UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM
(Mark One)
☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31 2021
OR
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROMTO
Commission File
Eargo, Inc.
(Exact name of Registrant as specified in its Charter)
Delaware | 27-3879804 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
2665 North First Street, Suite 300 San Jose, California | 95134 | |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code:(650) (650) 351-7700
Securities registered pursuant to Section 12(b) of the Act:
Title of each class | Trading Symbol(s) | Name of each exchange | ||
Common Stock, par value $0.0001 per share | EAR | The Nasdaq Stock Market LLC |
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES Yes☐NONo☒
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☐NONo☒
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES Yes☒ NO No☐
Indicate by check mark whether the Registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of(§ (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).YESYes☒ NO No☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
Large accelerated filer | ☐ | Accelerated filer | ☐ | |||
Non-accelerated filer | ☒ | Smaller reporting company | ☒ | |||
Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
Indicate by check mark whether the Registrant is a shell company (as defined in
The aggregate market value of the voting and2021,2022, was $1,069,948,866.
The number of shares of Registrant’s Common Stock outstanding as of May 4, 2022March 20, 2023 was
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s definitive proxy statement relating to the 2023 Annual Meeting of Stockholders to be filed electronically pursuant to Regulation 14A not later than 120 days after the end of the fiscal year ended December 31, 2022, are incorporated herein by reference in Part III.
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Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 57 | ||||
Item 7A. | 76 | |||||
Item 8. | 77 | |||||
Item 9. | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure | 104 | ||||
Item 9A. | 104 | |||||
Item 9B. | 105 | |||||
Item 9C. | Disclosure Regarding Foreign Jurisdictions that Prevent Inspections | 105 | ||||
Item 10. | 106 | |||||
Item 11. | 106 | |||||
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters | 106 | ||||
Item 13. | Certain Relationships and Related Transactions, and Director Independence | 106 | ||||
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Item 16. |
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Special note regarding forward-looking statements
This Annual Report on Form
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We have based these forward-looking statements largely on our current expectations, estimates, forecasts and projections about future events and financial trends that we believe may affect our financial condition, results of operations, business strategy and financial needs. In light of the significant uncertainties in these forward-looking statements, you should not rely upon forward-looking statements as predictions of future events. Although we believe that we have a reasonable basis for each forward-looking statement contained in this Annual Report on Form
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PART I
Item 1. Business.
Overview
Eargo, Inc. (“Eargo,” the “Company,” “we,” “us” or “our”) is a medical device company dedicated to improving the quality of life of people with hearing loss. Our innovative products and
We believe Eargo hearing aids are the first ever virtually invisible, rechargeable, completelyexempt Class I and Class II devices indicated to compensate for mild to moderate hearing loss.
We market and sell our hearing aids primarily in ateam which includes audiologists and hearing professionals.team. Our differentiated, consumer-first approach empowers consumers to take control of their hearing by improving accessibility, with personalized, high-quality telecare-basedremote customer support from our hearing professionals (with telecareremote customer support continuing for as long as a customer owns their Eargo hearing aid).
In an industry that has, in our opinion, historically been associated with limited brand awareness, we have developed a sophisticated brand-building strategy focused on consumer empowerment. We have also developed a robust technology and data-driven marketing platform that utilizes business intelligence, key performance metrics, machine learning and other marketing data to reinforce our growing brand recognition and to identify demographics, behaviors and marketing channels most relevant to our target audience. Eargo’s sales consultants leverage our digital marketing platform, which utilizes data-driven insights to iterate our sales tactics and create promotional offers, each with the goal of driving lead generation and increasing inbound lead conversions. We also see opportunity in nurturing long-term relationships with our customers to drive repeat purchases and increase their lifetime value, an objective facilitated by our provision of unlimited telecareremote access to Eargo’s hearing professionals for the life of a customer’s Eargo hearing aid.
We have also established a highly capable research and development organization with what we believe is a rare combination of expertise in mechanical engineering, product design, audio processing, clinical and hearing science, consumer electronics and embedded software design. In addition, we employ strategic intellectual property protection in certain key areas. Our technical capabilities and commitment to innovation have allowed us to deliver significant product enhancements on a rapid development timeline, exemplified by our launch of sixseven iterations of the Eargo hearing aid system since 2017 (four of which we are marketing and selling as of the filing date of this Annual Report onForm 10-K).
We believe that our differentiated hearing aids and consumer-centric approach have driven our sales of over 95,000109,000 Eargo hearing aid systems, net of returns, as of December 31, 2021.2022. We believe there is a large, growing and underserved market of people suffering from hearing loss, which we estimate included more thanapproximately 45 million adults (or approximately one in six adults) in the United States in 2021,2022, of whom only approximately 25% of whom actually owned a hearing aid.
The Eargo Difference
We are passionate about helping people hear better and are on a mission to change the way the world thinks about hearing loss.
Since our inception, our founding principle has been to dramatically improve the consumer experience at every step of the hearing care journey. Our products, customer support and marketing messaging are a direct result of that passion. We believe our primarily direct-to-consumer modeland omni-channel models can shift the paradigm in the treatment of hearing loss for the ultimate benefit of consumers.
Eargo hearing aids
Eargo hearing aids combine proprietary technology, engineeringAsWe market a variety of the filing datemodels of this Annual Report on Form10-K,we are marketing four versions of our hearing aids—the Eargo Max, the Eargo Neo HiFi, Eargo 5, and Eargo 6—aids to provide customers with a range of cost and functionality options. Each generation of Eargo hearing aids has been improved with additional features, such as audio performance, enhanced physical fit and/or comfort and greater ease of use.
Our
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We expect to continue refining and improving Eargo hearing aids, and we have the intention of an approximate annual cadence of new product launches. To this end, we are working on the development of a cost-conscious offering as well as the next Eargo hearing aid model with improved functionality.
Our business model and customer journey
We sell our hearing aids primarily on a
Eargo provides free educational resources as well as support from our team of sales consultants and hearing professionals, who help educate and guide prospective customers through addressing their hearing loss in a personalized and consultative experience.
While a hearing test is not necessary to purchase Eargo hearing aids, we offer an online,
Customers are able to complete purchases over the phone with an Eargo sales consultant or directly on our website. The Eargo purchasing experience is designed to be simple and to improve the accessibility of hearing aids. In addition, we offer a
Following the United States Food and Drug Administration (“FDA”) final rule regarding the creation of a new category of over-the-counter (“OTC”) hearing aids (the “OTC Final Rule”), we have focused efforts on transitioning to the new OTC framework and expanding our omni-channel approach, including exploring select additional commercial partnerships, retail, and other distribution opportunities. For example, we have a commercial arrangement with Victra, one of America’s largest wireless retailers, to facilitate access to our hearing screeners and demonstrate our devices at approximately 1,500 Victra store locations across the country; customers are also able to purchase or order Eargo hearing aids at such store locations. We believe that the OTC Final Rule may facilitate the opportunity to execute additional commercial partnerships, expanding our customers’ ability to learn about our hearing aids, obtain general information about their hearing through our current hearing screeners, and experience our devices in person prior to purchasing or ordering directly at retail locations.
Moreover, following the effective date of the OTC Final Rule, we have partnered with certain resellers and other distributors, including benefits managers, to offer Eargo hearing aids for sale through their online storefronts or portals. Under these partnerships, we sell Eargo hearing aids to resellers at wholesale prices, who in turn offer our products to end-customers through their respective online storefronts or portals. Generally, we fulfill and ship orders placed through these online storefronts or portals directly to end-customers, and we generally do not submit insurance claims on behalf of customers who purchase from one of these authorized resellers, including Victra. We believe these partnerships will help expand consumer access to our hearing aids and allow us to target high-intent customers more efficiently. We continue to look for additional partners to help expand our customer base.
Between December 8, 2021 and September 15, 2022, we did not accept insurance as a direct method of payment to the Company (referred to as “direct plan access” and discussed below under “—Insurance-Related Business—Insurance-Related Business following DOJ settlement”) and instead focused sales of our products are“cash-pay”only,to customers we refer to as “cash-pay” or “self-pay” customers, which includes upfront payment, credit card, and third-party financing, andas well as third-party distributor, payment.authorized reseller, or partner payments. We partner with a third-party monthly financing programproviders to make our products more accessible, and payment types may also be combined. TheWhen purchased directly through us, the Eargo hearing aid system is then shipped andtypically arrives on average in approximately three business days.
Once a customer purchases Eargo hearing aids, whether directly through us or through one of our partners, distributors, or authorized resellers, they are assigned to one of our hearing professionals, who provides complimentary, convenient support by phone, chat orOur hearing professionals include audiologists with degrees in audiology and speech-language science, professionals with board certifications in hearing aid science and other professionals.
Once a customer receives their Eargo hearing aids, their assigned hearing professional will schedule a welcome call to assist with proper use, fit and setting modification of the Eargo device. In 2021, more than 80% of our customers completed a welcome call with one of our hearing professionals. Our hearing professionals and customer care team are also available to provide unlimited support for as long as the customer owns an Eargo device. Additionally, we provide short, online training videos and other resources that customers can access online. The combination of these services allows us to deliver telecare-basedremote customer support in an efficient and streamlined manner.
We believe our business model and consumer-centric focus offer the followingcertain advantages relative to traditional sales channels (which are characterized by a:
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support as well as our consumer-centric experience
Insurance-Related Business
DOJ investigation and settlement and claims audits
As previously disclosed, on September 21, 2021, we were informed that we were the target of a criminal investigation by the DOJ related to insurance reimbursement claims we submitted for reimbursement on behalf of our customers covered by various federal employee health plans under the FEHB program.program, which is administered by the Office of Personnel Management (the “OPM”). The investigation also pertained to our role in customer reimbursement claim submissions to federal employee health plans (collectively, the “DOJ investigation”). Total payments the Company received from the government in relation to claims submitted under the FEHB program, as subject to the DOJ investigation, net of any product returns and associated refunds, were approximately $44.0 million. Also, as previously disclosed, our the third-party payor with whom historically we had the largest volume, which is one of the carriers contracted with the OPM under the FEHB program (“largest third-party payorpayor”), conducted an audit of insurance claims for reimbursement claims (“claims”) submitted by us (the “Primary Audit”), which included a review of medical records. We were informed by the third-party payor conducting the Primary Audit that the DOJ was the principal contact related to the subject matter of the Primary Audit. In addition to the Primary Audit, we have been subject to a number of other audits of insurance reimbursement claims submitted to additional third-party payors (collectively with the Primary Audit, the “claims audits”). One of these claims audits doesdid not relate to claims submitted under the FEHB program. On January 4, 2022, the DOJ confirmed to us that the investigation had been referred to the Civil Division of the DOJ and the U.S. Attorney’s Office for the Northern District of Texas and the criminal investigation was no longer active.
On April 29, 2022, we entered into a civil settlement agreement with the U.S. government that resolved the previously disclosed DOJ investigation related to our role in customer reimbursement claim submissions to various federal employee health plans under the FEHB program. We cooperated fully with the DOJ investigation. We deny the allegations in the settlement agreement, and the settlement is not an admission of liability by us. The allegations did not pertain to the quality or performance of our product. The settlement agreement provided for our payment of approximately $34.4 million to the U.S. government and resolved allegations that we submitted or caused the submission of claims for payment to the FEHB program using unsupported hearing loss-related diagnostic codes.
The settlement with the U.S. government may not resolve all of the audits of insurance reimbursement claimsinitiated by the various third-party payors, and additionally we remain subject to a prepayment review of claims by the payor who conducted the Primary Audit. We will need to work with the government (including the OPM) and third-party payors to potentially validate and establish processes to support any future claims that we may submit for reimbursement, and there are no guarantees that we will be able to arrive at any such acceptable processes or submit any future claims. We do not intend to submit any claims through the FEHB program until we are able to align with the OPM on and establish processes for supporting the submission of these claims.
From the time we learned of the DOJ investigation and until December 8, 2021, we continued to process orders for customers with potential insurance benefits (including FEHB program members) but suspended all claims submission activities and offered affected customers (iswas denied or ultimately not submitted by us to their insurance plan for payment (the “extended right of return”).
From December 8, 2021 until September 15, 2022, we made the decision to stop accepting insurance benefits as a method of direct payment and it is uncertain when, if ever, we will resume acceptingdid not accept insurance benefits as a method of direct payment. While we intend to work with the government and third-party payors at the appropriate time with the objective of validating and establishing processes to support any future claims that we may submit for reimbursement, we may not be able to arrive at acceptable processes or submit any future claims.
We estimatepreviously estimated that a majority of customers with unsubmitted claims as of December 31, 2021 willwould choose to return the hearing aid system if their insurance provider deniesdenied their claim or the claim iswas ultimately not submitted by us for payment, resulting in an increase in expected product returns from suchsales transactions that occurred prior to September 21, 2021. As a result, we2021 and recorded $13.3 million of estimated sales returns as a reduction in revenue in the third quarter of 2021 related to shipments to customers with potential insurance benefits. This has had a negative impact on the Company’s revenues forduring the year ended December 31, 2021 and resulted in an increase in the Company’s sales returns reserve. Of the $13.8 million sales returns reserve recorded as of December 31, 2021, $11.4 million relates to unsubmitted claims that are included in accounts receivable, net.2021. Returns associated with unsubmitted claims will reduce the sales returns reserve, with a corresponding reduction in the related accounts receivable at the time the product is returned.
We estimated that, in addition to the customers who choosechose to return their hearing aid systems, a significant number of customers whose claims arewere denied by insurance providerspayors or not submitted by us for payment maywould not pay for or return the hearing aid system. The $9.6 millionsystem, resulting in bad debt expense that was recorded during the year ended December 31, 2021 is primarily based on2021.
During the year ended December 31, 2022, we made the determination not to seek payment for approximately $16.1 million from customers with unsubmitted and unpaid claims. We accounted for this estimatedecision as a pricing concession and, has hadduring the year ended December 31, 2022 recorded a negative impact on$16.1 million reduction to our operating resultsinsurance-related accounts receivable balance, along with related
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reduction to net revenue of $11.6 million and an allowance for credit losses balance of $4.5 million for such unsubmitted and unpaid claims. Further, we simultaneously recorded a decrease in our insurance-related sales return reserve of $11.3 million, with a corresponding increase of $11.3 million to net revenue for the year ended December 31, 2021. Of the $9.6 million recorded to bad debt expense during the year ended December 31, 2021, $5.8 million relates to submitted claims that have been denied or have not been paid and was written off during the year ended December 31, 2021.
Insurance-related business following DOJ settlement
Between December 8, 2021 and September 15, 2022, we fileddid not accept insurance benefits as a Form12b-25notifyingdirect method of payment to the SECCompany, a practice we refer to as “direct plan access.” In “direct plan access,” we submit an insurance claim on behalf of an Eargo customer to their insurance plan, or support an Eargo customer in their own claim submission, and the customer’s insurance benefits are utilized for the purchase, in whole or in part. Common forms of utilization can include, but are not limited to, co-pay, payment by a third-party payor to either Eargo or the customer, reimbursement by a third-party payor to the customer, or application toward a customer’s deductible.
Because we do not currently have contracts with any FEHB carriers, third-party payors, or other insurance providers, our products are considered out-of-network with such payors and insurance providers. We do not believe that the reimbursement amounts, patient co-payment amounts, or the claims submission process, including medical necessity and other documentation requirements, depend on whether we are in-network or out-of-network with that FEHB carrier or other FEHB plans. To illustrate, the hearing aid benefit in an FEHB plan is a set amount that covers the hearing aid itself and related fees and supplies, regardless of the plan option and regardless of whether the hearing aid is provided by a preferred, participating, or non-participating provider (i.e., regardless of whether it is in-network or out-of-network), which is not always the case for other benefit categories. However, depending on the FEHB carrier or third-party payor, payment may be made directly to the patient rather than to us if Eargo is out-of-network.
Beginning on September 15, 2022, we resumed our direct plan access insurance-based business, accepting insurance benefits as a method of direct payment in certain limited circumstances, when the customer has undergone additional testing by an independent, licensed healthcare provider to establish medical necessity, with supporting clinical documentation. We are evaluating additional alternatives for testing or establishing medical necessity, including, but not limited to, contracting with third parties or existing networks of licensed healthcare providers, and/or establishing a management services organization, separate from our existing corporate structure, that manages professional entities that employ licensed healthcare providers. These alternatives involve significant time and related activities, including, but not limited to, development of additional internal processes, training, and compliance and quality control programs, coordination with external healthcare providers and professional services organizations, and evaluation of and compliance with state-by-state regulatory requirements. We cannot provide any assurance as to the efficacy of the processes that we wouldhave established or the extent to which such processes will need to be changed, or additional processes established, or the associated timing or costs, whether we will be successful in implementing any of them, or the impact that such processes and changes may have on our business and operations. If we are unable to timely filesuccessfully implement at least one of these alternatives for testing, or to otherwise establish additional acceptable processes to support claims that we may submit for reimbursement, we expect that we may not be able to submit future claims in sufficient volume to meaningfully restore or expand the amount of ourQ3 10-Q.
We are also seeking to establish relationships with benefits managers or managed care providers. Employer self-funded plans or other health plans may at times offer supplemental benefits, which may include hearing aid benefits or general “over-the-counter” benefits; they may in those cases contract with benefits managers or managed care providers in the administration of such supplemental benefits. In this role, among other things, benefits managers are responsible for selecting benefits vendors, i.e., vendors whose products or services are eligible to be covered by the supplemental benefit. The vendors themselves, or Eargo in this role, are not responsible for claims submissions but instead fulfill the product order from the customer through the benefits manager.
We cannot provide any assurances that we will be able to maintain or increase our participation in arrangements with third-party payors, insurance carriers, benefits managers, or managed care providers or that we will be adequately reimbursed or otherwise paid by such parties for the products we sell, which may have a material adverse effect on our financial condition, results of operations or cash flows.
Patient Square Capital Investment
On June 24, 2022, after reviewing all available alternatives to secure the funding needed to support our ongoing operations and pursuit of our business strategies, and a potential sale of the Company, we entered into an agreement (the “Note Purchase Agreement”) with PSC Echo, LP (the “PSC Stockholder”), an affiliate of Patient Square Capital (“Patient Square”), and Drivetrain Agency Services, LLC, as administrative agent and collateral agent. Pursuant to the Note Purchase Agreement, we issued approximately $105.5 million in two tranches of senior secured convertible notes (the “Notes”) and agreed to conduct a rights offering for an aggregate of 18.75
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million shares of common stock to stockholders as of a record date determined by our Board, at an offering price of $10.00 per share of common stock (the “Rights Offering”). Pursuant to the Rights Offering, which closed on November 18, 2021,23, 2022, we were notified bysold an aggregate of approximately 2.9 million shares to our existing stockholders, from which we received net proceeds of $27.6 million, and, in accordance with the terms of the Note Purchase Agreement, the Notes converted into 15,821,299 shares of our common stock, in each case, on a post-reverse stock split basis, representing approximately 76.3% of our outstanding common stock as of the date of conversion.
In connection with the Note Purchase Agreement, we had also entered into an Investors’ Rights Agreement with the PSC Stockholder, pursuant to which, among other things, the PSC Stockholder has the right to nominate a number of directors to our Board that is proportionate to the PSC Stockholder’s ownership of the Company, rounded up to the nearest whole number (and which shall in no event be less than one). As a result, following the closing of the Rights Offering and the conversion of the Notes, the PSC Stockholder has the right to nominate six directors to our Board. The PSC Stockholder exercised its right to nominate three directors to the Board, Trit Garg, M.D., Karr Narula and Justin Sabet-Peyman, in December 2022.
As of March 20, 2023, the PSC Stockholder held 15,821,299 shares, representing approximately 76.3% of our outstanding common stock. As a result of Patient Square’s ownership position, we are considered a “controlled company” within the meaning of the marketplace rules (the “Listing Rules”) of the Nasdaq Stock Market LLC (“Nasdaq”) that we were not in compliance with Nasdaq Listing Rule 5250(c)(1) for continued listing as a result of the delay in filing ourQ3 10-Qwith the SEC. In accordance with Nasdaq Listing Rules, we submitted a planand Patient Square may be able to regain compliance. Nasdaq granted us an exception of up to 180 calendar days from theQ3 10-Qoriginal filing due date, or until May 16, 2022, to regain compliance. On March 2, 2022, we filed a Form12b-25notifying the SEC that we would be unable to timely file this Annual Report on Form10-Kfor the year ended December 31, 2021. On March 4, 2022, we were notified again by Nasdaq that we were not in compliance with Nasdaq Listing Rule 5250(c)(1) for continued listing as a result of the delay in filing this Annual Report on Form10-K.As a result, we submitted to Nasdaq an update to our original plan to regain compliance. Nasdaq’s notification dated March 4, 2022 indicated that any additional exception to allow us to regain compliance withdetermine all untimely filings will be limited to a maximum of 180 calendar days from the due date of our Q310-Q,or May 16, 2022.
Seasonality
In the past we have experienced, and we may continue to experience, seasonality in our business, with higher sales volumes in quarters when we launchedcommercially launch new products and in the fourth calendar quarter as a result of holiday promotional activity; however, in part due toCOVID-19as well as a decline in gross systems shipped following announcementactivity. However, since our public disclosure of the DOJ investigation and our related decision to temporarily stop accepting insurance benefits as a method of direct payment between December 8, 2021 and September 15, 2022, we have experienced and may continue to experience a material decline in gross systems shipped (as further discussed in “—DOJ investigation and settlement and claims audits”),. As a result, seasonal factors did not have a material impact on our results of operations for the three months and year ended December 31, 2021.
Research and development
We are committed to ongoing research and development. Since 2017, we have launched sixseven generations of our hearing aids, (four of which we are currently marketing and selling), each adding performance and technical enhancements at different price points.
We are focused on continuing to launch new versions of the Eargo hearing aid with increased functionality and improved sound quality, amplification, noise reduction, fit, comfort, water resistance and
Manufacturing
We rely on a limited number of manufacturers for our products: Hana Microelectronics Group (“Hana”), a contract manufacturer based in Thailand. A secondThailand, as well as our primary manufacturer, Pegatron Corporation (“Pegatron”), headquartered in Taiwan and with manufacturing facilities in Suzhou, China,throughout Asia. Pegatron manufactures the Eargo 5, Eargo 6, and Eargo 67 hearing aid systems.systems out of its facilities in Suzhou, China. We rely on several third-party suppliers for the components used in our hearing aids, including semiconductor components, such as integrated circuits, as well as batteries, microphones and receivers.
We believe that these third-party facilities and suppliers will be adequate to meet our current and anticipated manufacturing needs. We do not currently plan to manufacture our hearing aids or any related components ourselves.
Manufacturing facilities that produce medical devices and/or their component parts intended for distribution world-wide are subject to regulation and periodic unannounced inspection by the FDA and other domestic and international regulatory agencies. In the United States, any products we sell are required to be manufactured in compliance with the FDA’s Quality System Regulation, which covers the methods used in, and the facilities used for, the design, testing, control, manufacturing, labeling, quality assurance, packaging, storage and shipping of our products.
The distribution of our hearing aids is handled directly through a third-party logistics provider. Our finished hearing aids are shipped from Hana and Pegatronour contract manufacturer to the third-party logistics provider’s facility and are distributed from there to customers.
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While we have not been directly impacted by any major disruption to our supply chain or access to necessary raw materials and component parts for the manufacture of our products to date that have impacted our ability to service customers, disruptions have occurred across a number of industries and we cannot provide any assurance that future disruptions will not emerge as a result of the ongoing supply chain issues, inflation, theextrinsicexternal factors. To date, increases in our product component pricing have occurred but have not had a material impact on supply continuity or gross margin. We have taken steps to monitor our supply chain and actions to address limited supply and increasing lead times, including outreach to critical suppliers and spot market purchases. For more information, please see the risks described under the caption “We rely on the timely supply of high-quality components, parts and finished products, and our business could suffer if suppliers or manufacturers are unable to procure raw materials or other components of an acceptable quality (or at all) or
Intellectual Property
We rely on a combination of patent, copyright, trademark and trade secret laws and confidentiality and invention assignment agreements to protect our intellectual property rights. As of December 31, 2021,2022, we had 2426 issued U.S. patents, 2226 patents outside the United States, 79 pending U.S. patent applications and 912 pending foreign patent applications. Our patents include utility patents covering technology ranging from remote control of our hearing aids to design patents covering the housing and securing mechanisms for our hearing aids. We have foreign patents in the EU, Australia, Canada, China, Germany, France, the United Kingdom, Japan, Singapore and South Korea. We own all of our patents and do not rely on any licenses to utilize the technology covered by these patents. The earliest of our patents is expected to expire in 2025. An issued U.S. patent with claims generally directed to an open ear canal hearing aid comprised of certain electronics and securing portions and an issued U.S. patent with claims generally directed to an adjustable securing mechanism for a space access device are each expected to expire in 2030.
Our pending patent applications may not result in issued patents, and we cannot assure you that any current or subsequently issued patents will protect our intellectual property rights. Third parties may challenge certain patents issued to us as invalid, may independently develop similar or competing technologies or may design around any of our patents. We cannot be certain that any of the steps we have taken will prevent the misappropriation of our intellectual property, particularly in foreign countries where the laws may not protect our proprietary rights in these countries as fully as in the United States.
There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry. Any litigation claims against us, independent of their validity, may result in substantial costs and the diversion of resources with no assurance of success. As of December 31, 2022, there is no active patent litigation involving us and we have not received any notices of patent infringement involving any of our products.
As of December 31, 2021,2022, we had 3435 trademark registrations and 106 pending trademark applications worldwide.
Competition
We compete in the hearing aid market against manufacturers, clinics and retailers of hearing aids, other
After a period of industry consolidation, five manufacturers control a vast majority of the global hearing aid industry today. These manufacturers are GN Store Nord, Sonova, Starkey, William Demant and WS Audiology, all of which have established products and substantially greater financial, sales and marketing, manufacturing and development resources than we possess. In addition to these manufacturers, we also compete against hearing clinics and retailers, such as Costco. Costco sells behind-the-ear, in-the-ear and in-the-canal hearing aids from traditional manufacturers, as well as its Kirkland Signature labelin store and also sellsbehind-the-ear,in-the-earandin-the-canalhearing aids under the Philips, Phonak, ReSound and Rexton
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various price points. We also compete against otherrecently acquired by GN Store Nord)Nord and rebranded as Jabra Enhance), which, similar to our business model, allow consumers to purchase hearing aids without visiting a clinic and provide remote support for their products.
Our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards or customer requirements, including with respect to changes to the industry landscape potentially arising as a result of the FDA’s Proposedadoption and implementation of the OTC Final Rule creating an(see “Government Regulation—Regulation by the FDA” for more information).
Prior to the effective date of the OTC Final Rule, no OTC category of hearing aids (see “Government Regulation—Regulation byexisted. The creation of the FDA—Proposed Rule for OTC category for hearing aids” for more information). Creation of a new category of OTC hearing aids by the FDA could materially alter the competitive environment for hearing loss treatment. The FDA and the Biden administration have stated that the intention of the ProposedOTC Final Rule to establish OTC hearing aids is to reduce barriers to access, foster innovation in hearing aid technology, and promote the wide availability of
In connection with the OTC Final Rule, we have expended, and will continue to expend, significant time and resources evaluating the OTC Final Rule and ensuring that our devices and processes comply with the new requirements in order to market our products in line with our primary direct-to-consumer business and omni-channel models. It is possible that the OTC Final Rule may lead to additional commercial partnership, omni-channel, including retail, or other opportunities, although there are no assurances that it will do so.
Considering the resources and advantages that our competitors maintain, even if our technology and consumer-first business model and distribution strategy are more effective than the technology and distribution strategy of our competitors, current or potential customers might accept competitor products in lieu of purchasing our products. We anticipate that we will face increased competition in the future, and may also experience intensifying pricing pressures, as existing companies and competitors develop new or improved products and distribution strategies and as new companies enter the market with new technologies and distribution strategies (possibly with increased frequency if and whendue to the FDA finalizes its Proposedimplementation of the OTC Final Rule, discussed above). We may not be able to compete effectively against these organizations. Our ability to compete successfully and to increase our market share is dependent upon our approach to addressing unmet needs in the hearing aid industry. Increased competition in the future could adversely affect our revenue, revenue growth rate, if any, margins and market share.
Government regulation
We operate in a complex regulatory environment with an extensive and evolving set of federal, state and local governmental laws, regulations, and other requirements. These laws, regulations and other requirements are promulgated and overseen by a number of different legislative, regulatory, administrative and quasi-regulatory bodies, each of which may have varying interpretations, judgments or related guidance. For example, our products and operations are subject to extensive and rigorous regulation by the U.S. Food and Drug Administration (the “FDA”), which regulates, among other things, the research, development, testing, design, manufacturing, approval, labeling, storage, recordkeeping, advertising, promotion, and marketing, distribution, post approvalpost-approval monitoring and reporting, and import and export of medical devices in the United States to assure the safety and effectiveness of medical products for their intended use. The U.S. Federal Trade Commission (the “FTC”) also regulates the advertising of our products in the United States. Further, we are subject to laws directed at preventing fraud and abuse, which subject our sales and marketing, training, and other practices to government scrutiny.
As such, we utilize considerable resources on an ongoing basis to monitor, assess and respond to applicable legislative, regulatory, and administrative requirements, but there is no guarantee that we will be successful in our efforts to adhere to all of these requirements. Additional discussion on certain of these laws, regulations and other requirements is set forth below in this section.
If any of our personnel, representatives or operations are alleged to have violated these or other laws, regulations or requirements, we could suffer severe consequences, including material harm to our reputation, that could have a material adverse effect on our business, results of operations, financial condition and cash flows, among other things.
We expect that our industry will continue to be subject to extensive and complex regulation, the scope and effect of which are difficult to predict. For additional detail on risks related to each of the foregoing, see the Risk Factors titled, “Changes in the regulatory landscape for hearing aid devices could rendermaterially impact ourmodel contrarymodels and lead to applicableincreased regulatory requirements, and we may be required to seek additional
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exclusion from participation in governmental healthcare programs and the curtailment of our operations, any of which could adversely impact our reputation and business operations.”
Regulation by the FDA
The FDA classifies hearing aids, including
The FDA classifies medical devices into three classes (Class I, II or III) based on the degree of risk associated with a device and the level of regulatory control deemed necessary to ensure its safety and effectiveness. Class I devices are those for which safety and effectiveness can be assured by adherence to the FDA’s general controls for medical devices, which include compliance with the FDA’s current good manufacturing practices (“cGMPs”) for devices, as reflected in the Quality System Regulation (“QSR”), establishment registration and device listing, reporting of adverse events, and truthful,510(k) de novo classification, which provides for the reclassification of the device into Class I or II. The PMA approval process is more stringent, time-consuming and expensive than the 510(k) clearance process; however, the 510(k) clearance process has also become increasingly stringent and expensive.
On August 17, 2022, the FDA published a final rule to establish new regulatory frameworkcategories forair-conductionand wirelessair-conductionhearing aids, which are classified as Class I and Class II devices, respectively, and are exempt from 510(k) clearance requirements. While applicable FDA regulations establish certain “conditions for sale”(the “OTC Final Rule”). The OTC Final Rule implements relevant provisions of all hearing aids, including that prospective hearing aid users must have a medical evaluation by a licensed physician within the six months prior to the hearing aid dispensation or sign a waiver of medical evaluation, the FDA has stated that it does not intend to enforce these medical evaluation and waiver requirements prior to the dispensing of Class Iair-conductionand Class II wirelessair-conductionhearing aids to individuals 18 years of age and older. Accordingly, while we are required to comply with other FDA requirements, our products are currently not reviewed by the FDA.
We have marketed in the effective date of the Final Rule in order topast, and continue to be marketed. For all other currently marketedmarket, certain Eargo system devices the proposed compliance date is 180 days after the effective date of the Final Rule (240 days after the publication of the Final Rule).
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In connection with the Proposed Rule. Once the FDA issues aOTC Final Rule, we have expended, and will assesscontinue to expend, significant time and resources evaluating the OTC Final Rule and intend to take steps as appropriate to ensureensuring that our devices and processes come intoare in compliance with anythe new applicable requirements in order to market our products in line with our primary direct-to-consumer business and omni-channel models. It is possible that the future.
Please see the Risk Factor titled, “Changes in the regulatory landscape for hearing aid devices could materially impact our direct-to-consumer business model and lead to increased regulatory requirements, and we may be required to seek additional clearance or approval for our products” for more information.
510(k) clearance
If not exempted from the FDA’s 510(k) notification requirement, to obtain 510(k) clearance for a medical device, an applicant must submit a premarket notification to the FDA demonstrating that the device is “substantially equivalent” to a legally marketed device, commonly known as the “predicate device.” A legally marketed predicate device may include a device that was legally marketed in the United States prior to May 28, 1976 for which a PMA is not required (commonly known as a“pre-amendments
Medical devices can be marketed only for the indications for which they are cleared or approved. After a device has received 510(k) clearance for a specific intended use, any change or modification that significantly affects its safety or effectiveness, such as a significant change in the design, materials or method of manufacture, or that would constitute a new or major change in intended use, may require a new 510(k) clearance or PMA approval and payment of an additional FDA user fee. The determination as to whether or not a modification constitutes such a change is initially left to the manufacturer using available FDA guidance; however, the FDA may review this determination to evaluate the regulatory status of the modified product at any time and may require the manufacturer to cease marketing and recall the modified device until new 510(k) clearance or PMA approval is obtained. The manufacturer may also be subject to significant regulatory fines or penalties.
Clinical trials
Clinical trials are sometimes required for 510(k) clearance. Such trials generally require submission of an investigational device exemption (“IDE”) application to the FDA for a specified number of patients and study sites, unless the product is deemed to be aIf an IDE is required, the FDA and theThe appropriate institutional review boards (“IRBs”) at the clinical sites must also approve the study before clinical trials may begin. Clinical trials are subject to extensive monitoring, record keeping and reporting requirements. Clinical trials must be conducted under the oversight of IRBs for the relevant clinical trial sites and must comply with FDA regulations, including but not limited to those relating to good clinical practices (“GCPs”), which include the requirement that all research subjects provide their informed consent for participation in each clinical study. The clinical trial sponsor, the FDA or the IRB could suspend or terminate a clinical trial at any time for various reasons, including a belief that the subjects are being exposed to an unacceptable health risk. Even if a trial is completed, the results of clinical testing may not adequately demonstrate the safety and effectiveness of the device or may otherwise not be sufficient to obtain FDA clearance to market the product.
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Labeling and sale
All hearing aids commercially distributed in the United States must comply with specific FDA labeling requirements. These requirements address the labeling of the device itself and any accompanying software, as well as the User Instructional Brochure that must be provided to all potential hearing aid recipients. Hearing aids must be clearly and permanently marked with, among other things,
Prior to the name of the device manufacturer, the model name or number, and the year of manufacture. In addition, the User Instructional Brochure must contain, among other things, specific instructions for the use of, maintenance and care of, and replacement or recharging of the batteries of the hearing instrument, information regarding known side effects that may warrant a physician consultation, a warning statement specified inOTC Final Rule, FDA regulations and technical data useful in selecting and fitting a hearing instrument and checking its performance.
Quality System Regulation
The hearing aids that we commercially distribute in the United States are subject to pervasive and continuing regulation by the FDA and certain state agencies. This includes product listing and establishment registration requirements, which facilitate FDA inspections and other regulatory actions. We are required to adhere to applicable current good manufacturing practice (“cGMP”)cGMP requirements, as set forth in the QSR, which require manufacturers, including third-party manufacturers, to follow stringent design, testing, control, documentation and other quality assurance procedures during all phases of the design and manufacturing process. We are also required to verify that our suppliers maintain facilities, procedures and operations that comply with applicable quality and regulatory requirements. The FDA enforces the QSR through periodic announced or unannounced inspections of medical device manufacturing facilities, which may include the facilities of contractors. FDA regulations also require investigation and correction of any deviations from the QSR and impose reporting and documentation requirements upon us and our third-party manufacturers. Noncompliance with these regulations can result in, among other things, fines, injunctions, civil penalties, recalls or seizures of products, total or partial suspension of production, FDA refusal to grant 510(k) clearance or PMA approval to new devices, withdrawal of existing clearances or approvals, and criminal prosecution.
Post-market surveillance
We must also comply with post-market surveillance regulations, including medical device reporting or MDR,(“MDR”) requirements which require that we review and report to the FDA any incident in which our products may have caused or contributed to a death or serious injury, and any incident in which our product has malfunctioned if that malfunction would likely cause or contribute to a death or serious injury if it were to recur. We must also comply with medical device correction and removal reporting regulations, which require manufacturers to report to the FDA corrections and removals if undertaken to reduce a risk to health posed by the device or to remedy a violation of the FDCA that may present a risk to health. Although we may undertake recall actions voluntarily, we must submit detailed information on any recall action to the FDA, and the FDA can order a medical device recall in certain circumstances.
In addition to post-market quality and safety actions, labeling and promotional activities are subject to scrutiny by the FDA and, in certain circumstances, by the FTC. Medical devices approved or cleared by the FDA may not be promoted for unapproved or uncleared uses, otherwise known as“off-label”
Failure to comply with applicable regulatory requirements, including delays in or failures to report incidents to the FDA as required under the MDR regulations, can result in enforcement action by the FDA, which can include any of the following sanctions:
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Other healthcare laws and regulations
The healthcare industry is also subject to federal and state fraud and abuse laws, including anti-kickback, self-referral, false claims and physician payment transparency laws, as well as patient data privacy and security and consumer protection and unfair competition laws and regulations. Our operations are also subject to certain state and local hearing care laws, including those applicable to the licensure and registration of audiologists and other individuals that dispense hearing aids, sales and marketing practices, interactions with consumers, consumer incentive and other promotional programs, and state corporate practice and
Fraud and abuse laws
In addition to the FDA, other broadly applicable federal and state healthcare laws and regulations apply to our operations and business practices. These laws may constrain the business or financial arrangements and relationships through which we conduct our operations, including our
In addition, the U.S. Physician Payments Sunshine Act (as amended by the Substance Use-Disorder Prevention that Promotes Opioid Recovery and Treatment for Patients and Communities Act) requires manufacturers to report to the Department of Health and Human Services (“HHS”) detailed information about financial arrangements with physicians and teaching hospitals and, with reporting requirements going into effect in 2022 for payments made in 2021, financial arrangements with(as defined by statute), certain non-physician practitioners, including physician assistants and nurse practitioners, and othermid-levelpractitioners.teaching hospitals. These reporting provisions preempt state laws that require reporting of the same information, but not those that require reports of different or additional information. Failure to comply subjects manufacturers to significant civil monetary penalties.
State licensing, corporate practice and
Regulation of the hearing aid industry exists in every state. These laws and regulations are primarily concerned with the licensure and registration of audiologists and other individuals and companies that dispense hearing aids, including procedures involving the fitting and dispensing of hearing aids. In addition, most states require warranty and return policies for consumers allowing for the return of product, and restrict hearing aid advertising and marketing practices. These state laws are subject to change, and states may impose more stringent requirements for dispensers of hearing aids. The FDCA preempts state laws relating to the safety and efficacy of medical devices and state laws that are different from or in addition to federal requirements. Although courts in certain jurisdictions have held that certain state laws relating to the fitting and dispensing of hearing aids, are preempted because they relate to the safety and efficacy of medical devices, interpretative legal precedent and regulatory guidance varies by jurisdiction and is often sparse and not fully developed, including which laws and regulations are subject to the federal preemption relating to safety and efficacy of medical devices, complicating
Our arrangements with hearing professionals may implicate certain state laws, commonly referred to as the corporate practice of learned professions, including audiology, and
Privacy and security
Numerous state, federal and Accountability Actforeign laws, regulations and standards govern the collection, use, access to, confidentiality and security of 1996health-related and its implementingother personal information and could apply now or in the future to our operations or the operations of our partners. In the United States, numerous federal and state laws and regulations, including data breach notification laws, health
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information privacy and security laws and consumer protection laws and regulations as amended bygovern the Health Information Technology for Economiccollection, use, disclosure, and Clinical Health Act (“HITECH”) (collectively referred to as “HIPAA”), imposes privacy, securityprotection of health-related and breach reporting obligations with respect to individually identifiable health information upon “covered entities” (health care providers, health plans and health care clearinghouses), and their respective business associates, individuals or entities that create, receive, maintain or transmit protected health information in connection with providing a service for or on behalf of a covered entity. HITECH increased the civil and criminal penalties that may be imposed against covered entities and business associates and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce HIPAA and seek attorneys’ fees and costs associated with pursuing federal civil actions. Additionally, HIPAA mandates the reporting of certain breaches of health information to the HHS, affected individuals and, if the breach is large enough, the media.
Foreign Corrupt Practices Act
The U.S. Foreign Corrupt Practices Act of 1977, as amended (the “FCPA”), prohibits U.S. businesses and their representatives from offering to pay, paying, promising to pay or authorizing the payment of money or anything of value to a foreign official in order to influence any act or decision of the foreign official in his or her official capacity or to secure any other improper advantage in order to obtain or retain business. The FCPA also obligates companies whose securities are listed in the United States, like us, to comply with accounting provisions that require us to maintain books and records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the corporation, including international subsidiaries, if any, and to devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances regarding the reliability of financial reporting and the preparation of financial statements. The scope of the FCPA includes interactions with certain healthcare professionals in many countries.
International laws
Globally, other countries have enacted anti-bribery laws and/or regulations similar to the FCPA. Violations of any of these anti-bribery laws, or allegations of such violations, could have a negative impact on our business, results of operations and reputation.
Additionally, as described above, there are also international privacy laws that impose restrictions on the access, use, and disclosure of health information and, as in the United States, there are significant and complex laws and regulations pertaining to our products and business model. To the extent we expand internationally, we will need to expend time and resources evaluating and complying with any such laws and regulations. For more information, see the Risk Factors titled, “Any future international expansion will subject us to additional costs and risks that may have a material adverse effect on our business, financial condition and results of operations” and “We operate in a regulated industry and changes in the regulations or the implementation of existing regulations could affect our operations and prospects for future growth.”
Environmental matters
Our operations, properties and products are subject to a variety of U.S. and foreign environmental laws and regulations governing, among other things, air emissions, wastewater discharges, management and disposal of hazardous and
Human capital management
Employees
As of December 31, 2021,2022, we had approximately 257243 full-time employees worldwide, of which approximately 250236 were employed in the United States. None of our employees is represented by a labor union or collective bargaining agreement, and we consider our employee relations to be good.
Talent attraction, development and retention
Our success depends in part on our continued ability to recruit, retain, develop and motivate a diverse population of talented employees at all levels of our organization. To succeed in a competitive industry, our human capital resources objectives include, as applicable, identifying, recruiting, retaining, incentivizing and integrating our existing and additional employees.
In addition to acquiring new talent, we focus on growing and developing our existing talent. We conduct regular individual performance reviews in which managers provide regular feedback and coaching to assist with employee development. We make investments to enhance employees’ skill levels and provide professional opportunities for career development and advancement. Our learning and development experiences focus on onboarding new hires as well as offering workshops focused on skills development, including leadership development programs and people manager coaching, and compliance training.
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Our leadership team focuses on identifying the next generation of leaders to ensure that the organization is prepared to fill critical roles with employees who are prepared to support the strategy of the business and respond to the needs of key stakeholders. Furthermore, although we had areduction-in-forceatreductions-in-force in the endfourth quarter of 2021 and the second quarter of 2022, we offered affected employees severance packages. Where possible, we offered opportunities for retraining
Diversity and reskilling certain employees to reduce the impact of thereduction-in-forceon our employees.
We view diversity as integral to our future success. Diversity in our workforce fosters innovation, while inclusion helps ensure that we have the right culture, processes, policies, and practices to make employees feel valued and included. Developing teams where team members feel heard, respected, and included is one of our core values. As of December 31, 2021,2022, approximately 40%46% of our total domesticUS workforce was female and approximately 25%34% of our employees in domestic managerial roles were female. Minorities35%37% of our total domesticUS workforce and approximately 35%31% of our employees in domestic managerial roles were minorities as of the same date.
Compensation and benefits
We focus on paying employees fairly and competitively. As a medical device company in the healthcare industry, we recognize the importance of compensation and benefits that are designed to support the financial, mental, and physical well-being of our team members and their families. Our compensation packages typically include incentive plans comprised of discretionary stock-based compensation awards and cash-based performance bonus awards, health benefits, including options for medical plans, pharmacy, dental and vision coverage, a 401(k) plan, life and disability insurance, discretionary paid time off, family leave, a technology stipend for remote work, commuter benefit program, and a program for partial education reimbursement. Eligibility for, and the level of, benefits vary depending on team members’ full-time or part-time status, work location, compensation level, and tenure.
Health, safety and safety
The physical health, financial wellbeing, life balance, and mental health of our employees are vital to our success. We remain focused on promoting the total wellness of our employees, including resources, programs and services to support their physical, mental and financial wellness. As a result ofThroughout theaugmented certain historical business practices to ensure that we promotepromoted the health, safety, and safetywellbeing of our employees. While we were never required to physically close our offices, we provided, when feasible, opportunities for employees to work remotely.and their families. We have established safety policies and protocols based on guidance from healthcare experts and public health leaders, and we regularly review and update our employees with respectthem to any changes. We also have adjusted attendance policies to encourage those who may be ill to stay home. To further protect ouron-siteemployees, we have made available personal protective equipment and cleaning supplies. We have also provided generalreflect the best, most current information updates and support for our employees to ensure that they have resources and information to protect their health and that of those around them, including their families and colleagues.
Available information
Our Internet address is www.eargo.com. We routinely post important information for investors on our website in the “Investor Relations” section, which may be accessed from our homepage at www.eargo.com or directly at https://ir.eargo.com/. We use this website as a means of disclosing material,
The content on our website is not incorporated by reference into, or a part of, this Annual Report on Form
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Item 1A. Risk Factors.
Risk factor summary
Below is a summary of the principal factors that make an investment in our common stock speculative or risky. This summary does not address all of the risks that we face. Additional discussion of the risks summarized in this risk factor summary, and other risks that we face, can be found below under the heading “Risk Factors” and should be carefully considered, together with other information in this Annual Report on Form
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Risk Factors
Our operating and financial results are subject to various risks and uncertainties. You should carefully consider the risks described below, as well as all of the other information contained in this Annual Report on Form
Risks relating to our industry and business
We face considerable uncertainty in our business prospects, as a significant portion of our revenue has historically been dependent upon reimbursement from third-party payors participating in the FEHB program, but we have operated on a “cash pay” onlyprimarily “cash-pay” basis since December 8, 2021. Following the civil settlement with the U.S. government on April 29, 2022, weWe may be unsuccessful in validating and establishing processes to support the submission of claims for reimbursement from third-party payors, including those participating in the FEHB program in the future.program. As a result, we have faced a significant reduction in revenue and any failure to establish additional processes to support reimbursement from third-party payors in the future may significantly and adversely impact our business and growth prospects and our ability to sell our products.
A significant portion of our revenue has historically been dependent on payments from third-party payors; for example, in the quarter ended September 30, 2021, 6,243 out of the 13,117 total gross systems shipped were for customers with potential insurance benefits. However, since December 8, 2021, we have not accepted insurance benefits asoperated on a method of direct payment.
Third-party payors periodically conduct
On April 29, 2022, we entered into a civil settlement agreement with the U.S. government that resolved the DOJ investigation. Pursuant to the settlement agreement, we paid approximately $34.4 million to the U.S. government. We cooperated fully with the DOJ investigation. We deny the allegations in the settlement agreement, and the settlement is not an admission of liability by us. While we will need to work with the OPM to align on the process and required documentation for potentially submitting claims through the FEHB program in the future, we may be unable to validate and establish processes to support the submission of claims for reimbursement to health plans under the FEHB program in the future. For example, we do not currently conductin-personhearing tests as they run counter to our primarydirect-to-consumerbusiness and omni-channel models. If a process by which we might be able to obtain reimbursement of claims for our products were to requirein-personhearing tests, we may not be able to efficiently or effectively integrate such tests into our operating model.
Between December 8, 2021 and September 15, 2022, we did not accept insurance benefits as a direct method of payment to us, a practice we refer to as “direct plan access.” In “direct plan access,” we submit an insurance claim on behalf of an Eargo customer to their insurance plan, or support an Eargo customer in their own claim submission, and the customer’s insurance benefits are utilized for the
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purchase, in whole or in part. Common forms of utilization can include, but are not limited to, co-pay, payment by a third-party payor to either Eargo or the customer, reimbursement by a third-party payor to the customer, or application toward a customer’s deductible.
Because we do not currently have contracts with any FEHB carriers or other third-party payors, our products are considered out-of-network for such payors. We do not believe that the reimbursement amounts, patient co-payment amounts, or the claims submission process, including medical necessity requirements and documentation requirements, depend on whether we are in-network or out-of-network for that FEHB carrier or other FEHB plans. To illustrate, the hearing aid benefit in this FEHB plan is a set amount that covers the hearing aid itself and related fees and supplies, regardless of the plan option and regardless of whether the hearing aid is provided by a preferred, participating, or non-participating provider (i.e., regardless of whether it is in-network or out-of-network), which is not always the case for other benefit categories. However, depending on the FEHB carrier or third-party payor, payment may be made directly to the patient rather than to us if Eargo is out-of-network.
Beginning on September 15, 2022, we resumed our direct plan access insurance-based business, accepting insurance benefits as a method of direct payment in certain limited circumstances, when the customer has undergone additional testing by an independent, licensed healthcare provider to establish medical necessity, with supporting clinical documentation. However, a majority of the claims we have submitted since instating this process are still pending adjudication by the payors, and although a portion of the claims we have submitted for reimbursement have been approved for payment and/or paid, others have been denied and are currently in the appeals process. We are evaluating additional alternatives for testing, including but not limited to contracting with third parties or existing networks and/or establishing a management services organization separate from our existing corporate structure that manages professional entities that employ licensed healthcare providers. These alternatives involve significant time and related activities, including, but not limited to, development of internal processes, training, and compliance and quality control programs, coordination with external healthcare providers and professional services organizations, and evaluation of and compliance with state-by-state regulatory requirements. We cannot provide any assurance as to the efficacy of the processes that we have recently established or the extent to which such processes will need to be changed, or additional processes established, or the associated timing or costs, whether we will be successful in implementing any of them, or the impact that such processes and changes may have on our business and operations. If we are unable to successfully implement at least one of these alternatives for testing, we expect that we will not be able to submit future claims in sufficient volume to meaningfully restore or expand the amount of our insurance-based business related to direct plan access going forward.
We intend to focus on both accessing third-party reimbursement and increasing coverage and reimbursement for our current products and any future products we may develop. However, we cannot provide any assurance as to the timing or costs associated with establishing processes to support the submission of claims, if we can do so at all, or the impact that such processes may have on our business and results of operations. Further, the OTC Final Rule may lead such payors to take additional actions further limiting our ability to access insurance coverage, or there may be a delay in accessing insurance coverage as payors seek to address the new OTC framework in their offered benefits, if at all, any of which may have a material adverse effect on our financial condition, results of operations or cash flows. Prior to the effective date of the OTC Final Rule, no OTC category of hearing aids existed, and certain carriers, including the third-party FEHB carrier with whom historically we had the largest volume, excluded from coverage so-called “over-the-counter” hearing aids and enhancement devices (such as personal sound amplification products, or “PSAPs”). Accordingly, the new regulatory category of OTC hearing aids created with the OTC Final Rule are not covered under certain plans as currently written, until such time as such carriers update their coverage policies to reflect the newly established OTC category under the OTC Final Rule, if ever. It is our understanding that the third-party FEHB carrier that administers approximately two-thirds of all FEHB benefits nationwide currently does not intend to update its coverage requirements for hearing aids following the recent OTC Final Rule. In addition, even if health plans update their coverage policies to include the new regulatory category of OTC hearing aids, they nonetheless may require a prescription, evaluation or diagnostic test conducted by a licensed healthcare professional to establish medical necessity and/or establish lower reimbursement rates for OTC hearing aids. Although we may seek to market certain of our devices as prescription hearing aids, payors, including the third-party FEHB carrier that administers approximately two-thirds of all FEHB benefits nationwide, may still not provide coverage for such devices because they are also offered OTC. We may need to work with individual carriers (including FEHB plans) to determine coverage for our hearing aids, including on a claim-by-claim basis with individual payors, which may be time-consuming and unpredictable. Coverage and payment levels are determined at each third-party payor’s discretion, and we have limited control over such third parties’ decision making with respect to coverage and payment levels or over their claims submissions processes and timelines. Coverage restrictions and reductions in reimbursement levels or payment methodologies may negatively impact our business and ability to sell products.
We are also seeking to establish further relationships with benefits managers or managed care providers. Employer self-funded plans or other health plans may at times offer supplemental benefits, which may include hearing aid benefits or general “over-the-counter” benefits; they may in those cases contract with benefits managers or managed care providers in the administration of such supplemental benefits. In this role, among other things, benefits managers are responsible for selecting benefits vendors or, in other words, vendors whose products or services are eligible to be covered by the supplemental benefit. The vendors themselves, or Eargo in this role, are not responsible for claims submissions but instead fulfill the product order from the customer through the benefits manager.
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We cannot provide any assurances that we will be able to maintain or increase our participation in arrangements with third-party payors, insurance carriers, benefits managers, or managed care providers or that we will be adequately reimbursed or otherwise paid by such parties for the products we sell, which may have a material adverse effect on our financial condition, results of operations or cash flows.
As a result of the change to a“cash-pay”only primarily “cash-pay” business model, we have faced a significant reduction in revenue and reduced growth prospects. If we are unable to establish processes to support reimbursement from third-party payors, in the future, our business and growth prospects and our ability to sell our products may be significantly and adversely impacted.
We cannot predict whether, under what circumstances, or at what payment levels third-party payors will cover and reimburse our products. If we fail to establish and maintain broad adoption of our products or fail to penetrate the insurance and managed care markets for our products, our ability to generate revenue could be harmed and our prospects and our business could suffer. To the extent we sell our products internationally, market acceptance may depend, in part, upon the availability of coverage and reimbursement within prevailing healthcare payment systems. Reimbursement and healthcare payment systems in international markets vary significantly by country and include both government-sponsored healthcare and private insurance. We may not obtain international coverage and reimbursement approvals in a timely manner, if at all. Our failure to receive such approvals would negatively impact market acceptance of our products in the international markets in which those approvals are sought. Please also see the Risk Factor titled, “Changes in the regulatory landscape for hearing aid devices could rendermaterially impact ourcontraryand lead to applicableincreased regulatory requirements, and we may be required to seek additional clearance or approval for our products.”
Our negative cash flows and current lack of financial resources raise substantial doubt as to our ability to continue as a going concern. Our future capital requirements may be substantial, and if we are unable to raise additional funding to meet our operational needs, we will be forced to limit or cease our operations and/or liquidate our assets.
We believe that, without any future financing, our current resources are insufficient to satisfy our obligations as they become due within one year from the date of filing of this Annual Report on Form 10-K. Our negative cash flows and current lack of financial resources raise substantial doubt as to our ability to continue as a going concern. We anticipate our future capital requirements will be substantial and that we will need to raise significant additional capital to fund our operations through equity or debt financing, or some combination thereof; however, additional capital may not be available to us on acceptable terms on a timely basis, or at all. If we are unable to raise additional funding to meet our operational needs, we will be forced to limit or cease our operations and/or liquidate our assets, in which case it is likely that investors would lose part or all of their investment.
Our expected future capital requirements and ability to raise additional capital will depend on many factors, including but not limited to the following:
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As a result of the Rights Offering and conversion of the Notes, our stockholders may have experienced substantial dilution of their holdings and the PSC Stockholder has obtained a controlling interest in us. If we raise additional funds through further issuances of equity or convertible debt securities, our existing stockholders could suffer significant further dilution, and any new equity securities we issue could have rights, preferences, and privileges superior to those of holders of our common stock.
Debt financing, if available, is likely to involve restrictive covenants limiting our flexibility in conducting future business activities. Even if we are able to raise significant additional capital necessary to continue our operations, if we are unable to obtain additional adequate financing or financing on terms satisfactory to us, when we require it, our ability to continue to pursue our business objectives, develop our technology and products, and respond to business opportunities, challenges, unforeseen circumstances, or developments, including the implementation of the OTC Final Rule, could be significantly limited, and our business, financial condition and results of operations could be materially adversely affected.
Adverse developments affecting the financial services industry, such as actual events or concerns involving liquidity, defaults or non-performance by financial institutions or transactional counterparties, could adversely affect our current and projected business operations and our financial condition and results of operations.
Actual events involving limited liquidity, defaults, non-performance or other adverse developments that affect financial institutions, transactional counterparties or other companies in the financial services industry or the financial services industry generally, or concerns or rumors about any events of these kinds or other similar risks, have in the past and may in the future lead to market-wide liquidity problems. For example, on March 10, 2023, Silicon Valley Bank (“SVB”) was closed by the California Department of Financial Protection and Innovation, which appointed the Federal Deposit Insurance Corporation (the “FDIC”) as receiver. On March 12, 2023, the Department of the Treasury, the Federal Reserve, and the FDIC jointly released a statement that depositors at SVB would have access to their funds, even those in excess of the standard FDIC insurance limits, under a systemic risk exception. As of March 10, 2023, we maintained cash in deposit accounts at SVB in excess of the standard FDIC insured amount and a substantial majority of our cash equivalents was invested, through a cash sweep arrangement with SVB, which are invested in a variety of short-term and high-credit bonds and other liquid investments. Although the FDIC ultimately announced that it would pay all deposits, including deposits that exceeded FDIC-insured amounts, we and other SVB customers initially were not able to access our accounts and faced significant uncertainty about whether and when we would be able to fully access amounts held through SVB, which would have had several follow-on consequences with respect to our ability to meet our near-term payment obligations. According to our cash sweep arrangements, we believe we should be recognized by the FDIC as the owner of such assets in the event of such financial institutions’ failure, such as the March 10, 2023 closure of SVB. While we have regained access to our funds at SVB, we have made and are making arrangements to open new and additional accounts with, and to transfer cash, cash equivalents and investments to such other financial institutions. We also continue to make arrangements to expand and evaluate our banking relationships in an effort to diversify as we believe necessary or appropriate. Additionally, we could experience disruption with customer receivables and vendor payments as we transition to new accounts.
Despite our proactive measures and the measures taken by the United States federal government, there is uncertainty in the markets regarding the stability of banks and the safety of deposits in excess of the insured deposit limits. The ultimate outcome of these events, and whether further regulatory actions will be taken, cannot be predicted. If any parties with whom we conduct business are impacted by the closure of SVB or any other financial institution, such parties’ ability to pay their obligations to us or to enter into new commercial arrangements requiring additional payments to us could be adversely affected. In this regard, counterparties to SVB credit agreements and arrangements, and third parties such as beneficiaries of letters of credit (among others), may experience direct impacts from the closure of SVB and uncertainty remains over liquidity concerns in the broader financial services industry.
In addition, if any of our partners, customers, suppliers or other parties with whom we conduct business are unable to access their own funds or access liquidity pursuant to credit agreements, letters or credit or other such lending arrangements or financial instruments as a result of financial institution volatility, such parties’ ability to pay their obligations to us or to enter into new commercial arrangements requiring additional payments to us could be adversely affected, which in turn, could have a material adverse effect on our business operations and financial condition and results or operations. Similar impacts have occurred in the past, such as during the 2008-2010 financial crisis.
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Further, these events may make equity or debt financing more difficult to obtain, and additional equity or debt financing might not be available on reasonable terms, if at all; difficulties obtaining equity or debt financing could have a material adverse effect on our financial condition, as well as our ability to continue to grow our operations.
We are subject to risks from legal proceedings, investigations and inquiries, including a number of recent legal proceedings and investigations, which have had and could continue to have a material adverse effect on our reputation, business, financial condition, cash flows and results of operations, and could result in additional claims and material liabilities.
We are currently subject to a number of legal proceedings, investigations and inquiries, including: (i) purported securities class action litigation alleging that certain of our disclosures about our business, operations and prospects, including reimbursementsreimbursement from third-party payors, violated federal securities laws; and (ii) purported derivative action alleging the directors breached their fiduciary duties by allegedly failing to implement and maintain an effective system of internal controls related to the Company’s financial reporting, public disclosures, and compliance with laws, rules and regulations governing the business. On April1.3. Legal Proceedings.”
We are unable to predict how long such legal proceedings, investigations and inquiries will continue, but we have incurred and anticipate that we will continue to incur significant costs in connection with these matters and that these legal proceedings, investigations and inquiries have resulted and will continue to result in substantial distraction of management’s time, regardless of the outcome. These legal proceedings, investigations and inquiries may result in damages, fines, penalties, consent orders or other sanctions (including exclusion from government programs and/or a recoupment of previous claims paid) against us and/or certain of our officers or directors, or in changes to our business practices, including the potential long-term shift to a primarily “cash-pay” model, excludingwith minimal volume from our customers using insurance benefits as a direct method of payment to Eargo. Furthermore, publicity surrounding these legal proceedings, investigations and inquiries or any enforcement action as a result thereof, even if ultimately resolved favorably for us, coupled with the recent intensified public scrutiny of our Company, could result in additional legal proceedings, investigations and inquiries. As a result, these legal proceedings, investigations and inquiries have
These legal proceedings, investigations and inquiries, and the uncertainty stemming from them, could also precipitate or heighten the other Risk Factors that we identify in this Item 1A, any of which could materially adversely impact our business. Further, these legal proceedings, investigations and inquiries may also affect our business and financial results in a manner that is not presently known to us or that we currently do not consider to present significant risks to our operations.
Additionally, we may become subject to other legal disputes and regulatory proceedings in connection with our business activities involving, among other things, product liability, product defects, intellectual property infringement and/or alleged violations of applicable laws in various jurisdictions. Although we maintain liability insurance in amounts we believe to be consistent with industry practice, we may not be fully insured against all potential damages that may arise out of any claims to which we may be party in the ordinary course of our business. A negative outcome of these proceedings may prevent us from pursuing certain activities and/or require us to incur additional costs in order to do so and pay damages.
The outcome of pending or potential future legal and arbitration proceedings is difficult to predict with certainty. In the event of a negative outcome of any material legal or arbitration proceeding, whether based on a judgment or a settlement agreement, we could be obligated to make substantial payments, which could have a material adverse effect on our business, financial condition and results of operations. In addition, the costs related to litigation and arbitration proceedings may be significant, and any legal or arbitration proceedings could have a material adverse effect on our business, financial condition and results of operations.
We have a limited operating history and have grown significantly in a short period of time. If we are unable to manage our business and anticipated growth effectively, our business and growth prospects could be materially and adversely affected.
We were organized in 2010 and began selling hearing aids in 2015. In that time, we have grown significantly, increasing the size of our organization and expanding our business. We have expanded, and any growth that we experience in the future will require us to further expand, our sales, clinical, and research and development personnel (including those with software and hardware expertise), our manufacturing operations and our general and administrative infrastructure. As a public company, we need to support increased managerial, operational, financial and other resources. Rapid expansion in personnel could mean that less experienced people develop, market and sell our products, which could result in inefficiencies and unanticipated costs, reduced quality and disruptions to our operations. In addition, rapid and significant growth may strain our administrative and operational infrastructure.
The challenges we face in managing our business, including our potential long-term shift to a“cash-pay”only primarily “cash-pay” business model, the obstacles to our being able to obtain reimbursement for our products from third-party payors, and the changing regulatory landscape, place significant demands on our management, financial, operational, technological and other resources, and we expect that managing our business will continue to place significant demands on our management and other resources and will require us to
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continue developing and improving our operational, financial and other internal controls, reporting systems and procedures. In particular, the challenges in managing our business involve a number of areas, including recruiting and retaining sufficient skilled personnel, providing adequate training and supervision to maintain our high-quality product standards and regulatory compliance and preserving our culture and values. We may not be able to address these challenges in a cost-effective manner, or at all. In addition, we completed an employee workforce reductionreductions in the fourth quarter of 2021 and second quarter of 2022, which actions may continue to impact the attraction and retention of employees, as well as employee morale and productivity. We cannot assure you that any increases in scale, related improvements and quality or compliance assurance will be successfully implemented or that appropriate personnel will be available to facilitate the management and growth of our business. Failure to implement necessary procedures, transition to new processes or hire the necessary personnel could result in higher costs or an inability to meet demand. If we do not effectively manage our
If we fail to attract and retain senior management and key technology personnel, our business may be materially and adversely affected.
Our success depends in part on our continued ability to attract, retain and motivate highly qualified management, administrative and clinical and scientific personnel, including those with software and hardware expertise. We are highly dependent upon our senior management, particularly our President and Chief Executive Officer, as well as our senior technology personnel and other members of our senior management team. The unplanned loss of the services of any of our members of senior management could adversely affect our business until a suitable replacement can be found.
Competition for qualified personnel in the medical device field in general and the audiology field specifically is intense due to the limited number of individuals who possess the training, skills and experience required by our industry. In addition, our success also depends on our ability to attract, recruit, develop and retain skilled managerial, sales, administration, operating and technical personnel. We willintend to continue to review and, where necessary, strengthen our senior management as the needs of the business develop, including through internal promotion and external hires. However, there may be a limited number of persons with the requisite competencies to serve in these positions and we cannot assure you that we would be able to locate or employ such qualified personnel on terms acceptable to us, or at all. Therefore, the unplanned loss of one or more of our key personnel, or our failure to attract and retain additional key personnel, could have a material adverse effect on our business, financial condition and results of operations. Our ability to attract and retain such qualified personnel has been and may continue to be negatively impacted by the DOJ investigation or shareholder litigation, our recent workforce reductionreductions and suspension of certain of our equity compensation practices, and related negative publicity. In addition, to the extent we hire personnel from competitors, we may be subject to allegations that they have been improperly solicited or that they have divulged proprietary or other confidential information, or that their former employers own their research output.
We may experience difficulties in managing our business, and a deterioration in our relationships with our employees could have an adverse impact on our business.
We expect to rely on our managerial, operational, finance and other resources in order to manage our operations and continue our research and development activities. We may expand our international operations, which would subject us to the legal, political, regulatory and social requirements and economic conditions of these jurisdictions, and create a variety of potential operational challenges due to a variety of international factors, including local labor laws and regulations and managing a geographically dispersed workforce. Our management and personnel, systems and facilities currently in place may not be adequate to support our business. Our need to effectively execute our strategy requires that we:
Maintaining good relationships with our employees is crucial to our operations. As a result, any deterioration of the relationships with our employees could have a material adverse effect on our business, financial condition and results of operations. Our ability to attract and retain qualified personnel, and foster positive employee
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practices, volatility in the stock market, our share price and other factors could diminish the Company’s use or the value of the Company’s equity awards, putting the Company at a competitive disadvantage.
Additionally, material disruption to our business as a result of strikes, work stoppages or other labor disputes could disrupt our operations, result in a loss of reputation, increased wages and benefits or otherwise have a material adverse effect on our business, financial condition and results of operations.
We have a history of net losses, and we expect to incur additional substantial losses in the foreseeable future.
We have incurred net losses since inception, and we expect to incur additional substantial losses in the foreseeable future. For the years ended December 31, 20212022 and 2020,2021, we incurred net losses of $157.8$157.5 million and $39.9$157.8 million, respectively. As a result of our ongoing losses, as of December 31, 2021,2022, we had an accumulated deficit of $356.8$514.3 million. Since inception, we have spent significant funds on organizational and
The net losses we incur may fluctuate significantly from quarter to quarter and have and may continue to increasequarter. During the year ended December 31, 2022, net losses increased in part as a result of the costs involved in resolving the DOJ investigation, including the approximately $34.4 million we paid pursuant to the settlement agreement with the U.S. government, and other corrective actions and recoupment of previous claims paid, as well as other legal proceedings, and their duration and impact on our business generally. TheyNet losses may also fluctuate and increase as a result of the anticipated implementation of a pendingthe FDA’s new OTC hearing aid regulatory framework and any potential Medicare coverage for certain hearing aids, neither of which may ultimately be favorable to us.
Our long-term success is dependent upon our ability to successfully develop, commercialize and market our products, earn revenue, obtain additional capital when needed and, ultimately, to achieve profitable operations. The uncertainty regarding the extent to which we are able to validate and establish additional processes to support the submission of claims for reimbursement to health plans, including those under the FEHB program, if at all, in the future, the anticipated implementation of a pendingthe FDA’s new OTC hearing aid regulatory framework (which may lead insurance providers to take actions limiting our ability to access insurance coverage and may also generally result in additional compliance or other regulatory requirements for Eargo)coverage) and potential Medicareinsurance (including Medicare) coverage for certain hearing aids (which may not include Eargo hearing aids) will require that we evaluate and consider any changes to our business model as new information becomes available, including a potential long-term shift to a primarily “cash-pay” model, excludingwith minimal volume from our customers using insurance benefits as a direct method of payment to Eargo, which would likely result in a sustained increased cost of customer acquisition and a reduction in shipments, revenue, gross margin and higher operating expenses, which could have a material negative impact on our ability to achieve profitability and our growth prospects. We will need to generate significant additional revenue and raise significant additional capital to continue our operations and potentially achieve profitability. It is possible that even if we generate significant additional revenue and raise significant additional capital, we will not achieve profitability or that, even if we do achieve profitability, we may not maintain or increase profitability in the future. Without the benefit of customers with insurance coverage and significant additional capital, the future prospects of the Company and our ability to achieve profitability are uncertain.
Changes in the regulatory landscape for hearing aid devices could rendermaterially impact ourmodel contrarymodels and lead to applicableincreased regulatory requirements, and we may be required to seek additional clearance or approval for our products.
On August 17, 2022, the FDA published a final rule to establish new regulatory frameworkcategories forair-conductionwhich are classified as Class I or
We have marketed in the past, and continue to be cleared by the effective date of the Final Rule to continue marketing; for all other currently marketed devices, the proposed compliance date is 180 days after the effective date of the Final Rule (240 days after the publication of the Final Rule).
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not satisfy the requirements of the OTC Final Rule, we could be forced to cease distribution of our products, and we could be subject to additional enforcement action by the FDA.
We have expended, and we will needcontinue to expend, significant time and resources evaluating the OTC Final Rule and ensuring that our devices and processes come into compliancecomply with the new requirements in order to market our products in line with our primarybusiness and omni-channel models in the future.business models. It is possible that a finalized regulatory framework forthe OTC hearing aidsFinal Rule may lead to additional commercial partnership, omni-channel, including retail, or other opportunities, although there are no assurances that it will do so. The OTC Final Rule and the responses thereto by leading insurance providers could also materially impact our efforts to resume submitting claims for customers with potential insurance benefits or have other unforeseen impacts on our business and results of operations.
Finally, in October 2021, the Biden administration outlined its plan to expand government healthcare programs as part of its broader domestic spending bill, which includes, among other things, extending Medicare coverage to include hearing benefits. Congress has considered and is considering legislation that would provide for such coverage, for example, the Build Back Better Act (H.R. 5376), which was passed by the House on November 19, 2021. The bill, as passed by the House, would providehave provided Medicare coverage for certain hearing aids to individuals with specific types of hearing loss, furnished pursuant to a written order of a physician, qualified audiologist or other hearing aid professional, physician assistant, nurse practitioner or clinical nurse specialist. This bill hasThe Inflation Reduction Act, which was ultimately signed into law, however, did not yet been passed by the Senate, and weinclude a hearing aid benefit. We cannot predict the likelihood, nature, or extent to which Medicare or other government healthcare programs will cover hearing aids, if at all, or specifically our hearing aids, which are intended for “mild” or “moderate” hearing loss, in the future, or the impact of any such changes on our business, financial condition or results of operations.
If we cannot innovate at the pace of our hearing aid manufacturing competitors, we may not be able to develop or exploit new technologies in time to remain competitive.
The hearing aid industry has in the past experienced rapid shifts to new key technologies, including for example the switch from analog to digital hearing aids in the 1990s, that disrupted existing market patterns and led to a large-scale market realignment among customers and hearing aid manufacturers. For us to remain competitive, it is essential to develop and bring to market new technologies or to find new applications for existing technologies at an increasing speed. If we are unable to meet customer demands for new technology, or if the technologies we introduce are viewed less favorably than our competitors’ products, our results of operations and future prospects may be negatively affected. To meet our customers’ needs in these areas, we must continuously design new products, update existing products and invest in and develop new technologies. We will also need to anticipate consumer demand with respect to these technologies and which technological advances are most desirable in the hearing aids we sell. This need will result in requiring our employees to continue learning and adapting to new technologies, and our competing for highly skilled talent in a competitive market. Our operating results depend to a significant extent on our ability to anticipate and adapt to technological changes in the hearing aid market, maintain innovation, maintain a strong product pipeline and reduce the costs of producing high-quality new and existing hearing aids. Any inability to do so could have a material adverse effect on our business, financial condition and results of operations.
As we expand our product offerings to physical retail outlets and begin to rely on third parties outside of our control, any failure of such third parties to comply with applicable laws and regulations could negatively impact our brand image and business and lead to negative publicity and potential liability.
As we expand our product offerings to physical retail outlets, we must rely on third parties to comply with applicable regulatory requirements in the promotion and sale of our devices. These third-party retailers may have limited or no experience selling regulated products such as hearing aids. If our third-party retail partners fail to comply with applicable requirements, our operations could be disrupted and we may be required to contract with alternate retail partners, which could result in substantial delays and which could materially and adversely affect our business, financial conditions, results of operations and growth prospects. Any violation of applicable law by any retail partner could expose us to unforeseen potential liability or attract negative publicity for us and our brand, which could materially impact our business. In addition, our retail partners have limited experience marketing and selling hearing aids in retail settings. If they are unable to successfully market and sell our hearing aids, we or they may decide to terminate our partnerships, which could materially and adversely affect our business, financial conditions, results of operations and growth prospects.
We are deploying a new business model in an effort to disrupt a relatively mature industry. In order to successfully challenge incumbent business models and become profitable, we will need to continue to refine our product and strategy.
Our
Additionally, following the effective date of the OTC Final Rule on October 17, 2022, customers can now purchase or order Eargo hearing aids in certain physical retail settings. We believe that the OTC Final Rule may facilitate the opportunity to execute additional
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commercial partnerships and expand our potential customers’ opportunity to purchase our products at physical retail locations. Delivery of hearing aids via amodel and retail models represents a change from the traditional channel, which requiresthis modelthese models or may not find it preferable to the traditional channel. In addition, consumers may not respond to our direct and channel marketing campaigns or efforts, or we may be unsuccessful in reaching our target audience, particularly if we expand our sales efforts in foreign jurisdictions where our advertising and distribution model may be more heavily regulated. If consumers prove unwilling to adopt our model as rapidly or in the numbers that we anticipate, our business, financial condition and results of operations could be materially harmed.
Historically, the majority of hearing aids sold to customers who used insurance benefits as a method of direct payment to Eargo corresponded to claims for reimbursement to third-party payors under the FEHB program. While we will needare continuing to work with applicable third-party payors with the OPM to align on the processobjective of validating and required documentation for potentially submitting claims through the FEHB program in the future, we may be unable to validate and establishestablishing additional processes to support the submission of claims that we may submit for reimbursement, we may not be able to health plans under the FEHB programarrive at additional acceptable processes or submit future claims in the future.sufficient volume to meaningfully restore or expand our insurance-based business. As such, our future growth prospects may be dependent upon other opportunities, such as the pending OTC hearing aid regulatory frameworkFinal Rule and any potential Medicareinsurance coverage for certain hearing aids that we may be able to access.
We operate in a highly competitive industry, and competitive pressures could have a material adverse effect on our business.
The worldwide market for hearing aids is competitive in terms of pricing, product quality, product innovation and
In addition to these manufacturer competitors, Costco sells multiple brands of hearing aids, including those of the traditional manufacturers and Costco’s own white-label Kirkland Signature brand of hearing aid, at prices ranging from approximately $1,400 to $2,950 per pair.various price points. We estimate that during 2019, Costco dispensed approximately 14% of the hearing aids distributed in the United States, which percentage is expected to increase going forward. The United States Department of Veterans Affairs (the “VA”) is also a significant provider of hearing aids and provides hearing aids at no charge to its patients. We estimate that, in 2019,2022, the VA dispensed approximately 19%20% of the hearing aids distributed in the United States. Our products are not distributed by Costco, or on contract or currently eligible to be distributed by the VA.
We also face competition from other direct-to-consumer hearing aid providers. Similar to our business model, these hearing aid companies allow consumers to purchase hearing aids remotely, with no need to visit a clinic, and they also provide remote support. Given the similarities in our direct-to-consumer business model to these providers, if potential consumers opt to buy their hearing aids from these direct-to-consumer competitors, our business could be adversely affected.
Finally, in particular following the effective date of the OTC Final Rule, we may also face increased competition from companies that introduce new technologies, including consumer electronics companies that sell direct to consumers.consumers or other hearing aid companies that partner with other retailers or consumer electronics companies. For example, in May 2018, the FDA granted marketing clearance to Bose Corporation for a “self-fittingaid.aid,” and following the effective date of the OTC Final Rule, Nuheara will be selling its OTC self-fitting air-conduction hearing aids under branding by HP, Inc., while Sony Electronics has partnered with WS Audiology. The Bose self-fitting hearing aid was cleared under the FDA’s de novo premarket review pathway with the intended use to amplify sound for individuals 18 years of age or older with perceived mild to moderate hearing impairment, with noanticipated implementationeffective date of a pendingthe OTC hearing aid regulatory framework,Final Rule, that sell hearing aids directly to consumers or in partnership with other retailers may erode that advantage. Please see the Risk Factor titled, “Changes in the regulatory landscape for hearing aid devices could rendermaterially impact ourcontraryand lead to applicableincreased regulatory requirements, and we may be required to seek additional clearance or approval for our products.”
We may be unable to compete with these or other competitors, and one or more of such competitors may render our technology obsolete or economically unattractive. Please see the Risk Factor titled, “If we cannot innovate at the pace of our hearing aid manufacturing competitors, we may not be able to develop or exploit new technologies in time to remain competitive.” To the extent we expand internationally, we will face additional competition in geographies outside the United States. If we are unable to compete effectively with existing products or respond effectively to any new products developed by competitors, our business could be materially harmed. Increased competition may result in price reductions, reduced gross margins and loss of market share.
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We rely on the timely supply of high-quality components, parts and finished products, and our business could suffer if suppliers or manufacturers are unable to procure raw materials or other components of an acceptable quality (or at all) or otherwise fail to meet their delivery obligations, raise prices or cease to supply us with components, parts or products of acceptable quality.
We rely on a limited number of critical suppliers for many of the components that are used in the manufacture of our products, including for semiconductor components, such as integrated circuits, as well as batteries, microphones and receivers. We are dependent on these third-party manufacturers and suppliers to identify and purchase quality raw materials, semi-finished goods and finished goods while seeking to preserve our quality standards. This reliance and dependence on third parties adds additional risks to the manufacturing process that are beyond our control. For example, the occurrence of epidemics or pandemics, such as the
In addition, many of these suppliers also provide components and products to our competitors. The industry’s reliance on a limited number of key components and product suppliers subjects us to the risk that in the event of an increase in demand or shortage of key materials or components, our suppliers may fail to provide supplies to us in a timely manner while they continue to supply our competitors, many of which have greater purchasing power than us, or seek to supply components to us at a higher cost. Lead times for materials, components and products ordered by us or by our contract manufacturers can vary significantly and depend on factors such as contract terms, demand for a component, and supplier capacity. From time to time, we may experience and have experienced component shortages and extended lead times, as well as increased component costs and increased logistics costs, including on semiconductor components and batteries, and other components used in our products.
For example, we have at times experienced, and expect to continue to periodically experience, price increases in certain of our critical components due to commodity price inflation. Additionally, while we have taken certain steps to alleviate cost pressures on freight shipping of our components and products, logistics costs may continue to increase and there can be no assurance that our cost-saving measures will continue to offset such logistics price increases. While we continue to monitor our supply chain and have taken and are taking actions to address limited supply and increasing lead times, including outreach to critical suppliers and spot market purchases, future disruptions in our supply chain, including the sourcing of certain components and raw materials by us or our suppliers, such as semiconductor and memory chips, as well as increased logistics and inflationary costs, could impact our sales and gross margins as well as launch and shipment of our products. The failure of our suppliers or manufacturers to deliver components or products in a timely fashion could have disruptive effects on our ability to produce our products in a timely manner, or we may be required to find new suppliers or manufacturers at an increased cost, ifor we may be unable to find replacement suppliers or manufacturers at all. Shortages or interruptions in the supply of components or subcontracted products, or our inability to procure these components or products from alternate sources at acceptable prices in a timely manner, could delay launch or shipment of our products or increase our production costs, which could adversely affect our business and operating results. The effects of climate change, including extreme weather events, long-term changes in temperature levels and water availability may exacerbate these risks. Such disruption has in the past impacted our costs and could in the future impact costs or interrupt our ability to source certain product components. A severe weather event in countries from which we source components and parts could cause disruptions in the Company’sour supply chain which could, in turn, cause product shortages, delays in delivery and/or increases in the Company’sour cost incurred to manufacture itsour products.
Any shortage, delay or interruption in the availability of our products, or key inputs used in their production, may negatively affect our ability to meet consumer demand. Additionally, our reputation and the quality of our products are in part dependent on the quality of the components that we source from third-party suppliers. If we are unable to control the quality of the components supplied to us or to address known quality problems in a timely manner, our reputation in the market may be damaged and sales of our products may suffer. As a result, we may experience a material adverse effect on our business, financial condition and results of operations.
Certain components needed to manufacture our hearing aids are only available from a limited number of suppliers.
Several of our suppliers provide products for our hearing aids and accessories for which they own the design and/or intellectual property rights. This includes semiconductor components, including integrated circuits, as well as transducers, batteries and various electrical components, some of which are highly customized. Although there may be several potential suppliers for our components, as our components are highly customized, there is a risk that these components may not be readily substituted by similar products of other suppliers or that any substitution may take a lengthy period of time to implement. Even if we do identify new suppliers, we may experience increased costs and product shortages as we transition to alternative suppliers. If any of these limited suppliers cease to supply us with their products, significantly increase their costs, or any of the foregoing events occurs, we could experience a material adverse effect on our business, financial condition and results of operations.
We rely on a limited number of manufacturers for the assembly of our hearing aids. If we encounter manufacturing problems or delays, we may be unable to promptly transition to alternative manufacturers and our ability to generate revenue will be limited.
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We have no manufacturing capabilities of our own. We currently rely on a limited number of manufacturers: one headquartered in Taiwan, with manufacturing facilities in Suzhou, China, Pegatron Corporation, for the manufacture of Eargo 5 and Eargo 6, and one located in Thailand, Hana Microelectronics, forand our primary manufacturer, Pegatron Corporation, headquartered in Taiwan and with manufacturing facilities throughout Asia. Pegatron manufactures the manufactureEargo 5, Eargo 6, and Eargo 7 hearing aid systems out of all other products currently available for sale.its facilities in Suzhou, China. For us to be successful, our contract manufacturers must be able to provide us with products in substantial quantities, in compliance with regulatory requirements, in accordance with agreed upon specifications, at acceptable costs and on a timely basis. While our existing manufacturers have generally met our demand and cost requirements on a timely basis in the past, their ability and willingness to continue to do so going forward may be limited for several reasons, including the volume of our orders and our relative importance as a customer of the manufacturer or its ability to provide assembly services to manufacture our products, which may be affected by thepandemic. pandemic and potential geopolitical events involving the countries in which our manufacturers are headquartered or operate. Please see the risk factor titled, “We are dependent on international manufacturers and suppliers, as well as certain international contractors we engage from time to time with respect to select research and development activities, which exposes us to foreign operational and political risks that may harm our business.” An interruption in our commercial operations could occur if we encounter delays or difficulties in securing these manufactured products if we cannot obtain an acceptable substitute.
Any transition to a new contract manufacturer, or any transition of products between existing manufacturers, could be time-consuming and expensive, may result in interruptions in our operations and product delivery, could affect the performance specifications of our products or could require that we modify the design of our products. If we are required to change either of our contract manufacturers, weWe will be required to verify that theany new manufacturer maintains facilities, procedures and operations that comply with our quality and applicable regulatory requirements, which could further impede our ability to manufacture our products in a timely manner. We cannot assure you that we will be able to identify and engage alternative or additional contract manufacturers on similar terms or without delay. Furthermore, our contract manufacturers could require us to move to a different production facility. The occurrence of any of these events could harm our ability to meet the demand for our products in a timely and cost-effective manner, which could have a material adverse effect on our business, financial condition and results of operations.
The manufacture of our products is complex and requires the integration of a number of components from several sources of supply. Our contract manufacturers must manufacture and assemble these complex products in commercial quantities in compliance with regulatory requirements and at an acceptable cost. Our hearing aids require significant expertise to manufacture, and our contract manufacturers may encounter difficulties in scaling up production of the hearing aids, including problems with quality control and assurance, component supply shortages, including any semiconductor components, increased costs, shortages of qualified personnel, the long lead time required to develop additional facilities for purposes of testing our products and/or difficulties associated with compliance with local, state, federal and foreign regulatory requirements. There can be no assurance that manufacturing or quality control problems will not arise in connection with the
If we are unable to successfully develop and effectively manage the introduction of new products, our business may be adversely affected.
We must successfully manage introductions of new or advanced hearing aid products. Introductions of new or advanced hearing aid products could also adversely impact the sales of our existing products to consumers. For instance, the introduction or announcement of new or advanced hearing aid products may shorten the life cycle of our existing devices or reduce demand, thereby reducing any benefits of successful hearing aid introductions and potentially lead to challenges in managing write-downs or write-offs of inventory of existing products. We may also not have success in transitioning customers from legacy hearing aids to new products. In addition, new hearing aid products may have higher manufacturing costs than legacy products, which could negatively impact our gross margins and operating results. As the technological complexity of our products increases, the infrastructure to support our products, such as our design and manufacturing processes and technical support for our products, may also become more complex. Accordingly, if we fail to effectively manage introductions of new or advanced products, our business may be adversely affected.
We experience challenges managing the inventory of existing hearing aids, which can lead to excess inventory and discounting of our existing devices. Inventory levels in excess of consumer demand may result in inventory write-downs or write-offs and the sale of inventory at discounted prices, which has affected our gross margin and could impair the strength of our brand. Reserves and write-downs for rebates, promotions and excess inventory are recorded based on our forecast of future demand. Actual future demand could
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be less than our forecast, which may result in additional reserves and write-downs in the future, or actual demand could be stronger than our forecast, which may result in a reduction to previously recorded reserves and write-downs in the future and increase the volatility of our operating results.
If the quality of our hearing aid products does not meet consumer expectations, or if our products wear out more quickly than expected, then our brand and reputation or our business could be adversely affected.
Our products may not perform as well in
Furthermore, because of our products’ limited time in the market, we cannot be certain about the usable life of our products. Due to the design constraints applicable to our rechargeable,form factor, design, our hearing aids may offer a shorter usable life compared to our competitors’ hearing aids. Thus, even though our products may be more affordable than competitive devices, they may need to be replaced more often. Although we believe the advantages of our design justify this tradeoff, customers may expect a longer useful life, and failure to live up to this expectation could result in reduced sales, decreased customer loyalty, higher-than-expected warranty claims and adverse publicity.
Certain components of our hearing aids may also offer reduced performance or wear out over time. For example, the rechargeable technology used in our hearing aids and charging cases has a limited lifespan, and recharging performance will degrade over time. We designed our Eargo Neo HiFi hearing aids to provide up to 20 hours of continuous use between charges when new and up to 16 hours after 1,000 charging cycles, but charging capacity may decrease more quickly than expected. Moreover, certain components of our hearing aids that can be purchased online, such as the hearing aid tips, will require more frequent replacement than the device itself. If the quality, longevity and durability of our products does not meet the expectations of customers, then our brand and reputation and our business, financial condition and results of operations, could be adversely affected.
Customer or third-party complaints or negative reviews or publicity about our company or our hearing aids could harm our reputation and brand.
We are heavily dependent on customers who use our hearing aids to provide good reviews andmodel and omni-channel models and products. Any negative reviews or negative publicity, including in relation to the DOJ investigation, the claims audits, and other legal proceedings have harmed and could continue to harm our reputation and brand and severely diminish consumer confidence in our products. Please also see the Risk Factor titled, “We are subject to risks from legal proceedings, investigations, and inquiries, including a number of recent legal proceedings and investigations, which have had and could continue to have a material adverse effect on our reputation, business, financial condition, cash flows and results of operations, and could result in additional claims and material liabilities.”
We spend significant amounts on advertising and other marketing campaigns to acquire new customers, which may not be successful or cost effective.
We market our hearing aids through a mix of digital and traditional marketing channels. These include paid search, digital display advertising, email marketing, affiliate and channel marketing, direct response television, national reach television, direct mail and select print and radio advertising. We also leverage our database of prospects and customers to further drive customer acquisition and referrals. We spend significant amounts on advertising and other marketing campaigns to acquire new customers, and we expect to continue to spend significant amounts to acquire new customers and increase awareness of our products. Beginning on December 8, 2021, we do not currently accepttemporarily stopped accepting insurance benefits as a method of direct payment. As a result, we have reduced sales and
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marketing resources that were previously focused on insurance customers to prioritize the conversion ofcash-payonly primarily “cash-pay” model is likely to increasehas increased the cost to acquire new customers, based on the historically lower conversion rate for
In addition, we believe that building a strong brand and developing and achieving broad awareness of our brand is critical to achieving market success. Negative publicity, including in relation to the DOJ investigation, the claims audits, and other legal proceedings has harmed and could continue to harm our reputation and brand and severely diminish consumer confidence in our products. If any of our brand-building activities prove less successful than anticipated, or such activities are inhibited by negative publicity in relation to the DOJ investigation, the claims audits and other legal proceedings, it could materially adversely impact our ability to attract new customers. If this were to occur, we may not be able to recover our brand-building spend, and our rate of customer acquisition may fail to meet market expectations, either of which could have a material adverse effect on our business, financial condition and results of operations. There can be no assurance that our brand-building efforts will result in increased sales of our products. See also the Risk Factors titled, “Customer or third-party complaints or negative reviews or publicity about our company or our hearing aids could harm our reputation and brand” and
Our products are complex to design and manufacture and could contain defects. The production and sale of defective products could adversely affect our business, financial condition and results of operations. If product liability lawsuits are brought against us, we may incur substantial liabilities and may be required to limit commercialization of our products.
We make hearing aids that include highly complex electronic components, which are sourced from external third parties, and there is an inherent risk that defects may occur in the production of any of our products. Although we rely on the suppliers’ internal procedures designed to minimize risks that may arise from quality issues, there can be no assurance that we or our suppliers will be able to eliminate or mitigate occurrences of these issues and associated liabilities. Under consumer product legislation in many jurisdictions, we may be forced to recall or repurchase defective products, and more restrictive laws and regulations relating to these matters may be adopted in the future. We also face exposure to product liability claims in the event that any of our devices are alleged to have resulted in personal injury or damage to property, or otherwise to have caused harm. For example, we may be sued if any of our hearing aids allegedly causes injury or is found to be otherwise unsuitable during product testing, manufacturing, marketing or sale. Any such product liability claims may include allegations of defects in manufacturing, defects in design, a failure to warn of dangers inherent in the product, negligence, strict liability and a breach of warranty. Claims could also be asserted under state consumer protection acts. If we cannot successfully defend ourselves against product liability claims, we may incur substantial liabilities or be required to limit commercialization of our products. Even successful defense would require significant financial and management resources. Regardless of the merits or eventual outcome, liability claims may result in:
Our inability to obtain and maintain sufficient product liability insurance at an acceptable cost and scope of coverage to protect against potential product liability claims could prevent or inhibit the sale of our current or any future products we develop. Although we currently carry product liability insurance, any claim that may be brought against us could result in a court judgment or settlement in an amount that is not covered, in whole or in part, by our insurance or that is in excess of the limits of our insurance coverage. Our
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insurance policies also have various exclusions and deductibles, and we may be subject to a product liability claim for which we have no coverage. We will have to pay any amounts awarded by a court or negotiated in a settlement that exceed our coverage limitations or that are not covered by our insurance, and we may not have, or be able to obtain, sufficient funds to pay such amounts. Moreover, in the future, we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses.
In addition, any product defects, recalls or claims that result in significant adverse publicity could have a negative effect on our reputation, result in loss of market share or failure to achieve market acceptance. For example, our first-generation hearing aid, launched in 2015, had a high incidence of product returns and warranty claims. As a result, we voluntarily withdrew the product from the market. The production and sale of defective products in the future could have a material adverse effect on our business, financial condition and results of operations.
We are subject to consumer protection laws that regulate our marketing practices and prohibit unfair or deceptive acts or practices. Our actual or perceived failure to comply with such obligations could harm our business, and changes in such regulations or laws could require us to modify our products or marketing or advertising efforts.
In connection with the marketing orand advertisement of our products, we could be the target of claims relating to false, misleading, deceptive, unfair, or otherwise unsubstantiated or noncompliant advertising or marketing practices, including under the auspices of federal or state rules or regulations such as the Federal Trade Commission Act and state consumer protection statutes. If we rely on third parties, including customers, to provide any marketing andor advertising of our products, including as we expand our product offerings in physical retail settings or through online channels, we could be liable for, or face reputational harm as a result of, their marketing practices if, for example, they or we fail to comply with applicable statutory and regulatory requirements.
If we are found or perceived to have breached any consumer protection, advertising, unfair competition or other laws or regulations, we may be subject to enforcement actions that require usrequired to change our marketing and business model, products or practices in a manner whichthat may negatively impact us. ThisWe could also result inbe subject to regulatory investigations, enforcement actions, litigation (including class actions), fines, penalties, increased compliance or remediation costs, and adverse publicity that could cause reputational harm and loss of customer trust, which could have a material adverse effect on our business, financial condition and results of operations.
There are a variety of hearing aid products and technologies, and consumer confusion about product features and technology could lead consumers to purchase competitive products instead of our products, or to conflate any adverse events or safety issues associated with third-party hearing aid products or other sound enhancement products with our products, which could adversely affect our business, financial condition and results of operations.
We believe that many individuals do not have full information regarding the types of hearing aids and hearing aid features and technologies available in the market, in part due to the lack of consumer education in the traditional hearing industry sales model. Consumers may not have sufficient information about hearing aids generally or how hearing aid products and technologies compare to each other. This confusion may result in consumers purchasing hearing aids from our competitors instead of our products, even if our hearing aids would provide
Our business, financial condition and results of operations may be impacted by the effects of the
We are subject to risks related to public health crises such as the global pandemic associated with
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Since the start of the pandemic, numerous state and local jurisdictions have imposed, and others in the future may impose,“shelter-in-place”
Disruptions in supply chain have resulted in industry-wide component supply (such as semiconductors) shortages, and we may not be able to obtain adequate inventory on a timely basis or at all. To date, increases in component pricing have occurred but have not had a material impact on supply continuity or gross margin. We have taken steps to monitor our supply chain and actions to address limited supply and increasing lead times, including outreach to critical suppliers and spot market purchases. Future disruptions in our supply chain, including the sourcing of certain components and raw materials, such as semiconductor and memory chips, as well as increased logistics costs, could impact our sales and gross margins.
The ultimate impact of
While the potential economic impact brought by and the duration ofliquidity, including our ability to repay our existing indebtedness.liquidity. In addition, a recession or market correction resulting from the spread ofFurther, although our sales volume has been positively impacted during theCOVID-19pandemic, this and any other favorable impacts we have experienced in connection with the pandemic may subside, and theThe ultimate effect of
Repair or replacement costs due to guarantees we provide on our products could have a material adverse effect on our business, financial condition and results of operations.
We provide product guarantees to our customers, both as a result of contractual and legal provisions and for marketing purposes.
We generally allow for the return of products from direct customers within 45 days after the original sale and record estimated sales returns as a reduction of sales in the same period revenue is recognized. We also generally allow customers to return defective or damaged products for a replacement or refund. The term of the warranty provided is typically two years for our latest device and one year for all other devices. Existing and future product guarantees place us at the risk of incurring future repair and/or replacement costs. As of December 31, 2021,2022, we had provisions of approximately $4.0$3.8 million relating to warranties. Substantial amounts of product guarantee claims could have a material adverse effect on our business, financial condition and results of operations.
In addition, we reserve for the estimated cost of product warranties when revenue is recognized, and we evaluate our warranty reserves periodically by reviewing our warranty repair experience. While we engage in product quality programs and processes, including monitoring and evaluating the quality of our components sourced from our suppliers and instituting methods to remotely detect and correct defects, our warranty obligation is affected by actual product defect rates, parts and equipment costs and service labor costs incurred in correcting a product defect. Our warranty reserves may be inadequate due to undetected product defects, unanticipated component failures or changes in estimates for material, labor and other costs we may incur to replace projected product defects. As a result, if actual product defect rates, parts and equipment costs or service labor costs exceed our estimates, it could have a material adverse effect on our business, financial condition and results of operations.
Our failure to successfully anticipate sales returns may have a material adverse effect on our business, financial condition and results of operations.
Our reported net revenue and net losses are affected by changes in reserves to account for sales returns and product credits. The reserve for sales returns accounts for customer returns of our products after purchase. We record a reserve for sales returns estimated based on historical return trends together with current product sales performance in each reporting period. If actual returns are greater than those projected and reserved for by management, additional sales returns reserve may be recorded in the future and reported net revenue may be reduced accordingly. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—DOJ investigation and settlement and claims audits” for more information.
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We do not currently have the ability to resell all products that are returned. Our refurbishment capabilities include full refurbishment, conversion, andare focused on components and allow us to refurbish and resell or reuse certain key components from our returned devices. To the extent we are unable to successfully refurbish devices in the future, we will not be able to resell such devices. Further, the introduction of new products, changes in product mix, changes in consumer confidence or other competitive and general economic conditions may cause actual returns to differ from product return reserves. Any significant increase in product returns that exceeds our reserves could have a material adverse effect on our business, financial condition and results of operations.
If we are unable to reduce our return rates or if our return rates continue to increase, our net revenue may decrease, and our business, financial condition and results of operations could be adversely affected.
Our customer sales returns rate was approximately 32%34% for the year ended December 31, 2021, which does not include the impact of the $5.1 million of estimated sales returns recorded as a reduction in revenue in the third quarter of 2021 related to transactions that occurred during the first and second quarters of 2021 (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—DOJ investigation and settlement and claims audits” for more information).2022. Our return policy generally allows our customers to return hearing aids for any reason within the first 45 days of delivery for a full refund, subject to a handling fee in certain states. Additionally, following learning of the DOJ investigation and prior to shifting to our current
We report revenue net of expected returns, which is an estimate informed in part by historical return rates. As such, our return rate impacts our reported net revenue and profitability. Our net revenue and profitability have been and will continue to be negatively impacted by the inability to recognize revenue related to shipments to customers with potential insurance benefits, which customers generally have had a significantly lower rate of return as compared to
Accelerated consolidation and formation of purchasing groups increases the pricing pressure on hearing aids.
Many purchasing groups, such as hearing aid clinics, retailers and hospital systems, are consolidating to create new entities with greater market power. Such groups, such as Costco and the VA, have used and may continue to use their increased purchasing power to negotiate price reductions or other concessions across our industry. This pricing leverage has resulted, and will likely continue to result, in downward pressure on the average selling prices of hearing aid products generally, including our own products. The forthcoming OTC Final Rule could further contribute to the pace of consolidation as well as the introduction of new entrants in the hearing aid market, which would further increase pricing pressure on hearing aid manufacturers. Please see the Risk FactorFactors titled, “Changes in the regulatory landscape for hearing aid devices could rendermaterially impact ourmodel contrarymodels and lead to applicableincreased regulatory requirements, and we may be required to seek additional clearance or approval for our products.products,” and “As we expand our product offerings to physical retail outlets and begin to rely on third parties outside of our control, any failure of such third parties to use comply with applicable laws and regulations could negatively impact our brand image and business and lead to negative publicity and potential liability.” These factors could have a material adverse effect on our business, financial condition and results of operations.
Alternative technologies or therapies that improve or cure hearing loss could adversely affect our business, financial condition and results of operations.
If medical research were to lead to the discovery of alternative therapies or technologies that improve or cure the various forms of hearing loss as an alternative to the hearing aid, such as by surgical techniques, the use of pharmaceuticals or breakthrough
Adapting our production capacities to evolving patterns of demand is expensive, time-consuming and subject to significant uncertainties. We may not be able to adequately predict consumer trends and may be unable to adjust our production in a timely manner.
We market our products directly to consumers in the United States, where we face the risk of significant changes in the demand for our products. If demand decreases, we will need to implement capacity and cost reduction measures involving restructuring costs. If demand increases, we will be required to make capital expenditures related to increased production and expenditures to hire and train production and sales and product support personnel. Adapting to changes in demand inherently lags behind the actual changes because it takes time to identify the change the market is undergoing and to implement any measures taken as a result. Finally, capacity
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adjustments are inherently risky because there is imperfect information, and market trends may rapidly intensify, ebb or even reverse. We have in the past not always been, and may in the future not be, able to accurately or timely predict trends in demand and consumer behavior or to take appropriate measures to mitigate risks and exploit opportunities resulting from such trends. Any inability in the future to identify or to adequately and effectively react to changes in demand could have a material adverse effect on our business, financial condition and results of operations.
We are dependent on international manufacturers and suppliers, as well as certain international contractors we engage from time to time with respect to select research and development activities, which exposes us to foreign operational and political risks that may harm our business.
We currently rely on a limited number of manufacturers: one headquartered in Taiwan, with manufacturing capabilities in Suzhou, China, Pegatron Corporation, for the manufacture of Eargo 5 and Eargo 6, and one located in Thailand, Hana Microelectronics, forand our primary manufacturer, Pegatron Corporation, headquartered in Taiwan and with manufacturing facilities throughout Asia. Pegatron manufactures the manufactureEargo 5, Eargo 6, and Eargo 7 hearing aid systems out of all other products currently available for sale.its facilities in Suzhou, China. In addition, we rely on some third-party suppliers in Europe, Southeast Asia, Japan, China and the United States, who supply, among other things, certain of the technology and raw materials used in the manufacturing of our products. We also engage certain international consultants, contractors and other specialists in connection with our research and development activities.
Our reliance on international operations exposes us to risks and uncertainties, including:
If any of these risks were to materialize, it could have a material adverse effect on our business, financial condition and results of operations.
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We or the third parties upon whom we depend may be adversely affected by disasters, and our business continuity and disaster recovery plans may not adequately protect us from a serious disaster. Any interruption in the operations of our or our suppliers’ manufacturing or other facilities may have a material adverse effect on our business, financial condition and results of operations.
Our corporate headquarters are located in the San Francisco Bay Area, which has experienced both severe earthquakes and wildfires.wildfires as well as flooding and power outages. We do not carry earthquake insurance. Our manufacturers and many of our suppliers are located in Asia, which regions have experienced natural disasters such as earthquakes, landslides, flooding, tropical storms and tsunamis, and tornadoes. Our customer support operations are based in Nashville, Tennessee, andas well as our third-party provider’s distribution facilities are based in Louisville, Kentucky, bothregions of whichthe Southern United States that have experienced flooding and tornadoes. Severe weather (including any potential effects of climate change), natural disasters and other calamities, such as pandemics (including
If a natural disaster, power outage or other event occurred that prevented us from using all or a significant portion of our headquarters or other facilities, or those of our third-party manufacturers or suppliers, that damaged critical infrastructure, such as our enterprise financial systems or manufacturing resource planning and enterprise quality systems, or that otherwise disrupted operations, it may be difficult or, in certain cases, impossible, for us to continue our business for a substantial period of time. A mechanical failure or disruption affecting any major operating line may result in a disruption to our ability to supply customers, and standby capacity may not be available. The disaster recovery and business continuity plans we have in place currently are limited and are unlikely to prove adequate in the event of a serious disaster or similar event. The potential impact of any disruption would depend on the nature and extent of the damage caused by a disaster. There can be no assurance that alternative production capacity will be available in the future in the event of a major disruption or, if it is available, that it could be obtained on favorable terms. We may incur substantial expenses as a result of the limited nature of our disaster recovery and business continuity plans, which, particularly when taken together with our lack of earthquake insurance, could have a material adverse effect on our business, financial condition and results of operations.
Furthermore, integral parties in our supply chain are similarly vulnerable to natural disasters or other sudden, unforeseen and severe adverse events. If such an event were to affect our supply chain, it could have a material adverse effect on our business, financial condition and results of operations.
We depend on sales of our hearing aids for our revenue. Demand for our hearing aids may not increase due to a variety of factors.
We expect that revenue from sales of our hearing aids will continue to account for our revenue for the foreseeable future. Continued and widespread market acceptance of hearing aids by consumers is critical to our future success. Consumer spending habits are affected by, among other things, prevailing economic conditions, levels of employment, salaries and wage rates, interest rates, inflation rates, consumer confidence and consumer perception of economic conditions, which have been adversely affected by theif at all, in the future, the anticipated implementation of a pendingthe new OTC hearing aid regulatory framework (which may lead insurance providers to take actions limiting our ability to access insurance coverage and may also generally result in additional compliance or other regulatory requirements for Eargo and may limit our ability to access insurance coverage) and potential Medicare coverage for certain hearing aids (which may not include Eargo hearing aids) will require that we evaluate and consider any changes to our business model as new information becomes available, including a potential long-term shift to a primarily “cash-pay” model, excludingwith minimal volume from our customers using insurance benefits as a method of direct payment to Eargo, which would likely result in a sustained increased cost of customer acquisition and a reduction in shipments, revenue, gross margin, and higher operating expenses, which could have a material negative impact on our profitability and growth prospects. Without the benefit of customers with insurance coverage, the future growth prospects and profitability of the Company are uncertain, unless we can identify new sources of profitable growth.
Further, a general slowdown in the U.S. economy and international economies into which we may expand or an uncertain economic outlook could adversely affect consumer spending habits, which may result in, among other things, a reduction in consumer spending on elective or higher value products, a preference for lower cost products, or a reduction in demand for
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adverse effect on our business, financial condition and results of operations. If we are not successful in adapting our production and cost structure to the market environment, we may experience further adverse effects that may be material to our business, financial condition and results of operations. See also the Risk Factor titled, “We face considerable uncertainty in our business prospects, as a significant portion of our revenue has historically been dependent upon reimbursement from third-party payors participating in the FEHB program, but we have operated on a “cash pay” onlyprimarily “cash-pay” basis since December 8, 2021. Following the civil settlement with the U.S. government on April 29, 2022, weWe may be unsuccessful in validating and establishing processes to support the submission of claims for reimbursement from third-party payors participating in the FEHB program in the future.program. As a result, we have faced a significant reduction in revenue and any failure to establish processes to support reimbursement from third-party payors in the future may significantly and adversely impact our business and growth prospects and our ability to sell our products.”
We will beare subject to “conflict minerals” reporting obligations.
We will beare required to diligence the origin of minerals used in the manufacture of our products that have been designated “conflict minerals” under the Dodd-Frank Wall Street Reform and Consumer Protection Act and, beginning in May 2023, disclose and report whether or not such minerals originated in the Democratic Republic of the Congo or adjoining countries. These requirements could adversely affect the sourcing, availability and pricing of minerals used in the manufacture of our products. In addition, we will incur additional costs to comply with the disclosure requirements, including costs related to determining the source of the relevant minerals and metals used in our products.
Any future international expansion will subject us to additional costs and risks that may have a material adverse effect on our business, financial condition and results of operations.
Historically, all of our sales have been to customers in the United States. To the extent we enter into international markets in the future, there are significant costs and risks inherent in conducting business in international markets. If we expand, or attempt to expand, into foreign markets, we will be subject to new business risks, in addition to regulatory risks. In addition, expansion into foreign markets imposes additional burdens on our executive and administrative personnel, finance and legal teams, research and marketing teams and general managerial resources.
We have limited experience with regulatory environments and market practices internationally, and we may not be able to penetrate or successfully operate in new markets. We may also encounter difficulty expanding into international markets because of limited brand recognition in certain parts of the world, leading to delayed acceptance of our products by consumers in these international markets. If we are unable to expand internationally and manage the complexity of international operations successfully, it could have a material adverse effect on our business, financial condition and results of operations. If our efforts to introduce our products into foreign markets are not successful, we may have expended significant resources without realizing the expected benefit. Ultimately, the investment required for expansion into foreign markets could exceed the results of operations generated from this expansion.
We primarily rely on our own direct sales force, and if we are unable to maintain or expand our sales force, it could harm our business. Additionally, our reliance on our direct sales force may result in higher fixed costs than our competitors and may slow our ability to reduce costs in the face of a sudden decline in demand for our products.
We primarily rely on our own direct sales force to market and sell our products. We do not have any long-term employment contracts with the members of our direct sales force. Our operating results are directly dependent upon the sales and marketing efforts of our sales and customer support team. If our employees fail to adequately promote, market and sell our products, our sales could significantly decrease. As we launch new products, expand our product offerings and increase our marketing efforts with respect to existing products, we will need to expand the reach of our marketing and sales networks. Our future success will depend largely on our ability to continue to attract, hire, train, retain and motivate skilled employees with significant technical knowledge in various areas. New hires require training and take time to achieve full productivity.
Additionally, most of our competitors rely predominantly on third-party distributors. Although we are beginning to expand our product offerings to physical retail locations of third parties and as a result will begin to rely on such third parties’ sales forces, we anticipate that we will continue to rely predominantly on our own direct sales force for the foreseeable future. A direct sales force may subject us to higher fixed costs than those of competitors that market their products through independent third parties, due to the costs that we will bear associated with employee benefits, training and managing sales personnel. As a result, we could be at a competitive disadvantage. Additionally, these fixed costs may slow our ability to reduce costs in the face of a sudden decline in demand for our products, which could have a material adverse effect on our business, financial condition and results of operations.
We rely on our relationship with a professional employer organization for our human relations function and as a
All of our U.S. personnel, including our executive officers, are
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administering all payroll, including tax withholding, and providing health insurance and other benefits for these individuals, and our employees are governed by the work policies created by Insperity. We reimburse Insperity for these costs and pay Insperity an administrative fee for its services. If Insperity fails to comply with applicable laws or its obligations under this arrangement or creates work policies that are viewed unfavorably by employees, our relationship with our employees could be damaged. We could, under certain circumstances, be held liable for a failure by Insperity to appropriately pay, or withhold and remit required taxes from payments to, our employees. In such a case, our potential liability could be significant and could have a material adverse effect on our business.
Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited.
We do not expect to become profitable in the near future, may never achieve profitability, and have incurred substantial net operating losses (“NOLs”) during our history. Unused NOLs will carry forward to offset a portion of future taxable income, if any, until such unused NOLs expire, if ever. Federal NOLs generated after December 31, 2017 are not subject to expiration, but the yearly utilization of such federal NOLs is limited to 80 percent of taxable income for taxable years beginning after December 31, 2020. In addition, in general, under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended (the “Code”), a corporation that undergoes an “ownership change” (within the meaning of Section 382 of the Code) is subject to limitations on its ability to utilize its prechangepre-change NOLs or tax credits to offset future taxable income or taxes. For these purposes, an ownership change generally occurs where the aggregate stock ownership of one or more stockholders or groups of stockholders who own at least 5% of a corporation’s stock increases by more than 50 percentage points over the lowest percentage of the corporation’s stock owned by such stockholders within a specified testing period.
We have experienced an ownership change within the meaning of Section 382 of the Code in the past, for which an estimate has been accounted for in our deferred tax disclosure. We may experience additional ownership changes in the future as a result of shifts in our stock ownership (some of which shifts may be outside our control). While we do not expect any limitation would impact our ability to use our tax attributes before they expire, we may be unable to use a material portion of our NOLs and other tax attributes even if we attain profitability.
Risks relating to intellectual property and legal and regulatory matters
If we fail to comply with U.S. or foreign federal and state healthcare regulatory laws, we could be subject to penalties, including, but not limited to, administrative, civil and criminal penalties, damages, fines, disgorgement, exclusion from participation in governmental healthcare programs and the curtailment of our operations, any of which could adversely impact our reputation and business operations.
We operate in a complex regulatory environment with an extensive and evolving set of federal, state and local governmental laws, regulations, and other requirements. These laws, regulations and other requirements are promulgated and overseen by a number of different legislative, regulatory, administrative and quasi-regulatory bodies, each of which may have varying interpretations, judgments or related guidance. For example, broadly applicable fraud and abuse and other healthcare laws and regulations apply to our operations and business practices. These laws may constrain the business or financial arrangements and relationships through which we conduct our operations, including our sales and marketing practices, consumer incentive and other promotional programs and other business practices.
Such laws include, without limitation:
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Foreign laws and regulations in this regard may vary greatly from country to country. For example, the advertising and promotion of our products in the European Economic Area (the “EEA”) would be subject to EEA Directives concerning misleading and comparative advertising and unfair commercial practices, as well as other EEA Member State legislation governing the advertising and promotion of medical devices. These laws may limit or restrict the advertising and promotion of our products to the general public and may impose limitations on our promotional activities with healthcare professionals. We are also subject to healthcare fraud and abuse regulation and enforcement by the countries in which we conduct our business. These healthcare laws and regulations vary significantly from country to country.
Ensuring that our internal operations and future business arrangements with third parties comply with applicable healthcare laws and regulations will involve substantial costs. We utilize considerable resources on an ongoing basis to monitor, assess and respond to applicable legislative, regulatory, and administrative requirements, but there is no guarantee that we will be successful in our efforts to adhere to all of these requirements. It is possible that governmental authorities will conclude that our business practices do not comply with current or future statutes, regulations, agency guidance or case law involving applicable fraud and abuse or other healthcare laws and regulations. If our operations are found to be in violation of any of the laws described above or any other governmental laws and regulations that may apply to us, we may be subject to significant penalties, including civil, criminal and administrative penalties, damages, fines, exclusion from government-funded healthcare programs, such as state Medicaid programs, TRICARE or similar programs in other countries or jurisdictions, disgorgement, imprisonment, contractual damages, reputational harm, diminished profits and the curtailment or restructuring of our operations. Further, defending against any such actions can be costly and time-consuming and may require significant personnel resources. Even if we are successful in defending against any such actions that may be brought against us, our business may be impaired.
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Our hearing aids are subject to extensive government regulation at the federal and state level, and our failure to comply with applicable requirements could harm our business.
Our hearing aids are medical devices that are subject to extensive regulation in the United States, including by the FDA and state agencies. The FDA regulates, among other things, the design, development, research, manufacture, testing, labeling,labelling, marketing, promotion, advertising, sale, import and export of hearing aid devices, such as those we market. Applicable medical device regulations are complex and have tended to become more stringent over time. Regulatory changes could result in restrictions on our ability to carry out or expand our operations.
The FDA classifies medical devices into one of three classes (Class I, II, or III) based on the degree of risk associated with a device and the level of regulatory control deemed necessary to ensure its safety and effectiveness. Class I devices are those for which safety and effectiveness can be assured by adherence to the FDA’s general controls for medical devices, which include compliance with the FDA’s current good manufacturing practices (“cGMPs”) for devices, as reflected in the Quality System Regulation (“QSR”), establishment registration and device listing, reporting of adverse events, and truthful,labeling, labelling, advertising, and promotional materials. Some Class I and Class II devices also require premarket clearance by the FDA through the premarket notification process set forth in Section 510(k) of the Federal Food, Drug and Cosmetic Act (“FDCA”).
We have marketed in the past, and wirelessair-conductionhearing aids, such as those wecontinue to market, certain Eargo system devices as Class I andair-conduction or Class II devices,wireless air-conduction hearing aids under existing regulations at 21 CFR 874.330 and 874.3305, respectively, both of which are exempt from 510(k) premarket review procedures; although we complyreview. In addition, in connection with applicable Class I and Class II medical device requirements, nonethe effective date of our devices have been reviewed by the FDA. Moreover, because the FDA has stated that it does not intend to enforce the medical evaluation requirements for dispensation of Class I or Class IIair-conductionhearing aids to individuals 18 years of age and older, our devices are available directly to consumers without the medical evaluation of a licensed practitioner. If our current or future products become subject to the pending OTC hearing aid framework, are deemed to be Class II “self-fittingair-conductionhearing aids,” or are otherwise required to undergo premarket review, for example, to come into compliance with the OTC Final Rule, we plan to market our devices as OTC hearing aids following the April 14, 2023 compliance date, or sooner. In addition, we may be requiredseek to first receivemarket certain devices as prescription hearing aids, which would require compliance with separate physical and electronic labeling requirements under the OTC Final Rule. In June 2022, we submitted a 510(k) premarket notification seeking FDA clearance under Section 510(k) of the FDCA or approval of a premarket approval (“PMA”) application from the FDA. If this were to occurexpanded labelling for our currently marketed devices,Eargo 5 and 6 hearing aids as “self-fitting” devices. On December 22, 2022, we received FDA 510(k) clearance for Eargo 5 and 6 as Class II self-fitting air-conduction hearing aids. In January 2023, we launched the FDA could require us to removeEargo 7 as our products from the market until we receive applicable regulatory clearance or approval, which would significantly impact our business.
In the 510(k) clearance process, before a device may be marketed, the FDA must determine that the proposed device is “substantially equivalent” to a legally-marketed “predicate” device, which includes a device that has been previously cleared through the 510(k) process, a device that was legally marketed prior to May 28, 1976 (a“pre-amendments”labelinglabelling data. The PMA process is typically required for Class III devices that are deemed to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices.
Modifications to products that are approved through a PMA application generally require FDA approval. Similarly, certain modifications made to products cleared through a 510(k) may require a new 510(k) clearance. Both the PMA approval and the 510(k) clearance process can be expensive, lengthy and uncertain. The FDA’s 510(k) clearance process usually takes from 3 to 12 months, but can last longer. The process of obtaining a PMA is much more costly and uncertain and generally takes from one to three years, or even longer, from the time the application is filed with the FDA. In addition, a PMA generally requires the performance of one or more clinical
Any delay or failure to obtain necessary regulatory clearances or approvals if required in the future could harm our business.
The FDA can delay, limit or deny clearance or approval of a device for many reasons, including:
In addition, the FDA may change its clearance and approval policies, adopt additional regulations or revise existing regulations, or take other actions, which may prevent or delay our ability to introduce new products or modify our current products on a timely basis. For example, in November 2018, FDA officials announced forthcoming steps that the agency intends to take to modernize the 510(k) premarket notification pathway, and in September 2019, the FDA finalized guidance to describe an optional “safety and performance based” premarket review pathway for manufacturers of certain “well-understood device types,” which would allow manufacturers to demonstrate substantial equivalence by meeting objective safety and performance criteria established by the FDA, obviating the need
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for manufacturers to compare the safety and performance of their medical devices to specific predicate devices in the clearance process. As another example, in the FDA’s OTC ProposedFinal Rule, the FDA states they are “undertaking other separate effortsthat it is separately proposing to minimize regulatory burdens for manufacturers by proposingharmonize the harmonization of part 820QSR with an international consensus standard.” If we are required to seek additional premarket review of our devices in the future or if the FDA proposes modifications to quality system requirements, these proposals and reforms could impose additional regulatory requirements on us and increase the costs of compliance.
We operate in a regulated industry and changes in the regulations or the implementation of existing regulations could affect our operations and prospects for future growth globally.
Our products and our business activities are subject to rigorous regulation in any jurisdictionsjurisdiction in which we operate, now or in the future. In particular, these laws generally govern: (i) coverage and reimbursement by the national health services or by private health insurance services for the purchase of hearing aids; (ii) the supply of hearing aids to the public and, more specifically, the training and qualifications required to practice the profession of hearing aid fitting specialist; and (iii) the development, testing, manufacturing, labeling,labelling, premarket clearance or approval and marketing, advertising, promotion, export and import of our hearing aids. Accordingly, our business may be affected by changes in any such laws and regulations and, in particular, by changes to the conditions for coverage, the way in which reimbursement is calculated, the ability to obtain national health insurance coverage or the role of the ear, nose and throat specialists.
While the FDA is the primary regulatory body affecting our business, which is currently based in the United States, there are numerous other regulatory schemes at the international, national and
Regulations pertaining to our products have become increasingly stringent and more common, particularly in developing countries whose regulations approach standards previously attained only by some Organisation for EconomicFor example, if certain of our products were made subject to less stringent regulation by the FDA in the United States, for example, in connection with the FDA’s promulgation of a regulatory framework for OTC hearing aids, then products similar to ours may be marketed and sold more freely, and our products may become commoditized. If the markets in which we operate become less regulated, those barriers to entry may be eliminated or reduced, which could have a material adverse effect on our business, financial condition and results of operations.
Both before and after a product is commercially released, we have ongoing responsibilities under various laws and regulations. If a regulatory authority were to conclude that we are not in compliance with applicable laws or regulations, or that any of our hearing aids are ineffective or pose an unreasonable risk for therendermaterially impact ourcontraryand lead to applicableincreased regulatory requirements, and we may be required to seek additional clearance or approval for our products.”
Disruptions at the FDA and other government agencies caused by funding shortages or global health concerns could hinder their ability to hire, retain or deploy key leadership and other personnel, or otherwise delay or prevent necessary regulatory clearances or approvals, which could negatively impact our business.
The ability of the FDA to review and clear or approve new products can be affected by a variety of factors, including government budget and funding levels, statutory, regulatory and policy changes, the FDA’s ability to hire and retain key personnel and accept the payment of user fees, and other events that may otherwise affect the FDA’s ability to perform routine functions. Average review times at the agency have fluctuated in recent years as a result. In addition, government funding of other government agencies that fund research and development activities is subject to the political process, which is inherently fluid and unpredictable. Disruptions at the FDA and other agencies may also slow the time necessary for new medical devices or modifications to be cleared or approved by government agencies, which would adversely affect our business. For example, over the last several years, including for 35 days
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beginning on December 22, 2018, the U.S. government has shut down several times and certain regulatory agencies, such as the FDA, have had to furlough critical FDA employees and stop critical activities.
Separately, in response to the on March 10, 2020, the FDA announced its intention to postponepostponed most inspections of domestic and foreign manufacturing facilities and on March 18, 2020,at various points. Even though the FDA temporarily postponed routine surveillance inspections of domestic manufacturing facilities. Subsequently, in July 2020, the FDA resumed certainon-siteinspections of domestic manufacturing facilities subject to a risk-based
Legislative or regulatory healthcare reforms may make it more difficult and costly to produce, market and distribute our products or to do so profitably.
Recent political, economic and regulatory influences are subjecting the healthcare industry to fundamental changes. Both the federal and state governments in the United States and foreign governments continue to propose and pass new legislation and regulations designed to contain or reduce the cost of healthcare, improve quality of care and expand access to healthcare, among other purposes. For example, the implementation of the Affordable Care Act has changed healthcare financing and delivery by both governmental and private insurers substantially and has affected medical device manufacturers significantly. Other legislative changes have also been proposed and adopted since the Affordable Care Act was enacted, which included, among other things, reductions to Medicare payments to providers through the Budget Control Act of 2% per fiscal year. These reductions went into effect in April 20132011 and due to subsequent legislative amendments to the statute, will remain in effect through 2030, with the exception of a temporary suspension from May 1, 2020 through March 31, 2022, unless additional action is taken by Congress. In addition, on January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law which, among other things, further reduced Medicare payments to certain providers, including hospitals. The2012. In addition, the Medicare Access and CHIP Reauthorization Act of 2015 (“MACRA”), enacted on April 16, 2015, repealed the formula by which Medicare made annual payment adjustments to physicians and replaced the former formula with fixed annual updates and a new system of incentive payments which began in 2019 that are based on various performance measures and physicians’ participation in alternative payment models such as accountable care organizations. Future legislation and regulatory changes, including, for example, the pendingnew OTC regulatory framework, may result in, directly or indirectly, decreased coverage and reimbursement for medical devices, which may further exacerbate industry-wide pressure to reduce the prices charged and impact market demand for medical devices. This could harm our ability to market and generate sales from our products.
Our hearing aids may cause or contribute to adverse medical events that we are required to report to the FDA, and if we fail to do so, we would be subject to sanctions that could harm our reputation, business, financial condition and results of operations. The discovery of serious safety issues with our products, or a recall of our products either voluntarily or at the direction of the FDA or another governmental authority, could have a negative impact on us.
We are subject to the FDA’s medical device reporting regulations and similar foreign regulations, which require us to report to the FDA when we receive or become aware of information that reasonably suggests that one or more of our hearing aids may have caused or contributed to a death or serious injury or malfunctioned in a way that, if the malfunction were to recur, it could cause or contribute to a death or serious injury. The timing of our obligation to report is triggered by the date we become aware of the adverse event as well as the nature of the event. We may fail to report adverse events of which we become aware within the prescribed timeframe. We may also fail to recognize that we have become aware of a reportable adverse event, especially if it is not reported to us as an adverse event or if it is an adverse event that is unexpected or removed in time from the initial use of the hearing aid device. If we fail to comply with our reporting obligations, the FDA could take action, including warning letters, untitled letters,
The FDA and foreign regulatory bodies have the authority to require the recall of commercialized medical device products in the event of material deficiencies or defects in design or manufacture of a product or in the event that a product poses an unacceptable risk to health. The FDA’s authority to require a recall must be based on a finding that there is reasonable probability that the device could cause serious injury or death. We may also choose to voluntarily recall a product if any material deficiency is found. A government-mandated or voluntary recall by us could occur as a result of an unacceptable risk to health, component failures, malfunctions, manufacturing defects, labelinglabelling or design deficiencies, packaging defects or other deficiencies or failures to comply with applicable regulations. We cannot assure you that product defects or other errors will not occur in the future. Recalls involving our hearing aids could have a material adverse effect on our business, financial condition and results of operations.
Medical device manufacturers are required to maintain certain records of recalls and corrections, even if they are not reportable to the FDA. We may initiate voluntary withdrawals or corrections for our hearing aid devices in the future that we determine do not require notification of the FDA. If the FDA disagrees with our determinations, it could require us to report those actions as recalls and we may be subject to enforcement action. A future recall announcement could harm our reputation with customers, potentially lead to product liability claims against us and negatively affect our sales.
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We must manufacture our products in accordance with federal and state regulations, and we could be forced to recall our products or terminate production if we fail to comply with these regulations.
The methods used in, and the facilities used for, the manufacture of our hearing aid devices must comply with the FDA’s QSR, which is a complex regulatory scheme that covers the procedures and documentation of the design, testing, production, process controls, quality assurance, labeling,labelling, packaging, handling, storage, distribution, servicing and shipping of medical devices. Furthermore, we are required to verify that our suppliers maintain facilities, procedures and operations that comply with our quality and applicable regulatory requirements. The FDA enforces the QSR through periodic announced or unannounced inspections of medical device manufacturing facilities, which may include the facilities of subcontractors, and such inspections can result in warning letters, untitled letters and other regulatory communications and adverse publicity. Our hearing aid devices are also subject to similar state regulations and various laws and regulations of foreign countries governing manufacturing.
We cannot guarantee that we or any subcontractors will take the necessary steps to comply with applicable regulations, which could cause delays in the manufacture and delivery of our products. In addition, failure to comply with applicable FDA requirements or later discovery of previously unknown problems with our products or manufacturing processes could result in, among other things:
Any of these actions could significantly and negatively impact supply of our products. If any of these events occurs, our reputation could be harmed, we could be exposed to product liability claims and we could lose customers and suffer reduced revenue and increased costs.
We are subject to numerous state and local hearing aid and licensure laws and regulations as well as state laws regulating the corporate practice of audiology or fee splitting, and
We are subject to numerous state and local hearing aid laws and regulations relating to, among other matters, licensure and registration of audiologists and other individuals we employ or contract with to provide services and dispense hearing aids. Many states also have laws that regulate the corporate practice of audiology, including exercising control, interfering with or influencing an audiologist or other hearing care specialist’s professional judgment and entering into certain financial arrangements, such as splitting professional fees with audiologists. Other state and local laws and regulations require us to maintain warranty and return policies for consumers allowing for the return of product and restrict advertising and marketing practices. These state and local laws and regulations are complex, change frequently and have tended to become more stringent over time; additionally, these laws and their interpretations vary from state to state and are enforced by state courts and regulatory authorities, each with broad discretion.
The FDCA preempts state laws relating to the safety and efficacy of medical devices and state laws that are different from or in addition to federal requirements; somerequirements. In addition, under FDARA, the OTC Final Rule preempts any state laws relatingor local requirement specifically related to licensure, business registration,hearing products that would restrict or administrative requirementsinterfere with commercial activity involving OTC hearing aids. However, the FDA made clear in its rulemaking that although a state or local government may not be consideredrequire the order, involvement, or intervention of a licensed person for consumers to be related to the safety and efficacy of medical devices and therefore may not be preempted. In Missouri Board of Examiners for Hearing Instrument Specialists v. Hearing Help Express, Inc. and METX, LLC v.Wal-MartStores Texas, LLC, the Eighth Circuit Court of Appeals and the U.S. District Court for the Eastern District of Texas, respectively, have held that certain state laws relating to the fitting and dispensing ofaccess OTC hearing aids, are preempted because they relate to the safety and efficacy of medical devices. Interpretative legal precedent and regulatory guidance vary by jurisdiction and are often sparse and not fully developed, including which laws and regulations are preempted, complicating our compliance efforts. Accordingly, we cannot be certain that our interpretation of laws and regulations applicable to our operations is correct, and regulatory authoritiesany person representing as a defined professional or other third parties may challenge our existing organization. If such a claim were successful, we could beestablishment remains subject to adverse judicialapplicable state and local requirements, even if the person undertakes commercial or administrative interpretations andprofessional activities only in relation to civil or criminal penalties.OTC hearing aids. Our ability to operate profitably will depend, in part, on our ability to obtain and maintain any necessary licenses and other approvals and operate in compliance with applicable state laws and regulations. A determination that we are in violation of applicable laws and regulations in any jurisdiction in which we operate could have a material adverse effect on us, particularly if we are unable to restructure our operations and arrangements to comply with the requirements of that jurisdiction, if we are required to restructure our operations and arrangements, including those with our audiologists and other licensed professionals, at a significant cost, or if we are subject to penalties or other adverse action.
Applicable federal laws and regulations continue to evolve. For example,In addition to the FDARA set forth a process to create a category of OTC hearing aids that are intended to be available without supervision, prescription, or other order, involvement or intervention of a licensed practitioner. The FDA is currently engaged in a rulemaking process to publish a final regulation regarding OTC hearing aids. Under FDARA,changes under the OTC hearing aid controls that are the subject of the rulemaking, if finalized, would preempt any state or local requirement specifically related to hearing products that would restrict or interfere with commercial activity involving OTC hearing aids. Additionally,Final Rule, the Biden Executive Order July 9, 2021 instructed the FTC to review overly restrictive occupational licensing requirements that may impede the ability for licensed individuals to move between states. We cannot predict the impact on our business of new or amended laws or regulations or any changes in the way existing and future laws and regulations are interpreted or enforced, nor can we ensure we will be able to
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obtain or maintain any required licenses or permits. See the Risk Factor titled, “Changes in the
We may face risks related to any future international sales, including the need to obtain necessary foreign regulatory clearance or approvals.
Sales of our products outside the United States will subject us to foreign regulatory requirements that vary widely from country to country. The time required to obtain clearances or approvals required by other countries may be longer than that required for FDA clearance or approval, and requirements for such approvals may differ from FDA requirements. We may be unable to obtain regulatory approvals and may also incur significant costs in attempting to obtain foreign regulatory approvals. If we experience delays in receipt of approvals to market our products in new jurisdictions, or if we fail to receive these approvals, we may be unable to market our products in international markets in a timely manner, if at all, which could materially impact our international expansion and adversely affect our business as a whole. Some international regulations may also limit the availability of our hearing aids to customers in certain jurisdictions without our first obtaining a license or engaging a third party to provide such financing, or limit the financing options we can offer our customers. If any of these risks were to materialize, they could limit our expected international expansion opportunities, which could have a material adverse effect on our business, financial condition and results of operations.
Regulations in certain foreign countries may challenge our
Our business may also be affected by actions of domestic and foreign governments to restrict the activities of
Our success depends in part on our proprietary technology, and if we are unable to obtain, maintain or successfully enforce our intellectual property rights, the commercial value of our products and services will be adversely affected and our competitive position may be harmed.
Our success and ability to compete depend in part on our ability to maintain and enforce existing intellectual property and to obtain, maintain and enforce further intellectual property protection for our products and services, both in the United States and in other countries. We attempt to protect our intellectual property rights through a combination of patent, trademark, copyright and trade secret laws, as well as licensing agreements and third-party confidentiality and assignment agreements. Our inability to do so could harm our competitive position. As of December 31, 2021,2022, we had 2326 issued U.S. patents, 1826 patents outside the United States, 79 pending U.S. patent applications and 1012 pending foreign patent applications.
We rely on our portfolio of issued and pending patent applications in the United States and other countries to protect our intellectual property and our competitive position. However, the patent positions of medical device companies, including our patent position, may involve complex legal and factual questions, and, therefore, the scope, validity and enforceability of any patent claims that we may obtain cannot be predicted with certainty. Accordingly, we cannot provide any assurances that any of our issued patents have, or that any of our currently
Changes in either patent laws or in interpretations of patent laws in the United States and other countries may diminish the value of our intellectual property or narrow the scope of our patent protection, which in turn could diminish the commercial value of our products and services. In addition, any protection afforded by foreign patents may be more limited than that provided under U.S. patent and intellectual property laws. There can be no assurance that any of our patents, any patents licensed to us or any patents which we may be issued in the future will provide us with a competitive advantage or afford us protection against infringement by others, or that the patents will not be successfully challenged or circumvented by third parties, including our competitors. Further, there can be no assurance that we will have adequate resources to enforce our patents.
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In addition, from time to time we engage international consultants, contractors and other specialists to assist in our research and development activities. Certain of these third parties may operate in jurisdictions where it is difficult or impossible for us to assert our intellectual property rights in case of infringement or theft, either as a statutory or practical matter. We have engaged in, and may in the future engage in, various contractual relationships with third parties outside the United States in connection with the development of our products, which may expose our technology and intellectual property to a heightened risk of unauthorized use or theft.
Any of the foregoing risks, individually or in the aggregate, could have a material adverse effect on our competitive position, business, financial condition, results of operations, and prospects.
If our trademarks and trade names are not adequately protected, we may not be able to build name recognition in our markets of interest and our competitive position may be harmed.
We rely on our trademarks, trade names and brand names to distinguish our products from the products of our competitors, and have registered or applied to register many of these trademarks. There can be no assurance that our trademark applications will be approved. Third parties may also oppose our trademark applications or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition, and could require us to devote resources to advertising and marketing new brands. Further, there can be no assurance that competitors will not infringe our trademarks or that we will have adequate resources to enforce our trademarks. We also license third parties to use our trademarks. In an effort to preserve our trademark rights, we enter into license agreements with these third parties, which govern the use of our trademarks and require our licensees to abide by quality control standards with respect to the goods and services that they provide under our trademarks. Although we make efforts to monitor the use of our trademarks by our licensees, there can be no assurance that these efforts will be sufficient to ensure that our licensees abide by the terms of their licenses. In the event that our licensees fail to do so, our trademark rights could be diluted. Any of the foregoing could have a material adverse effect on our competitive position, business, financial condition, results of operations, and prospects.
We may become involved in lawsuits to protect or enforce our intellectual property, which could be expensive, time-consuming and unsuccessful.
Third parties, including our competitors, could be infringing, misappropriating or otherwise violating our intellectual property rights. While we are not aware of any unauthorized use of our intellectual property, we do not regularly conduct monitoring for unauthorized use at this time. In the future, we may from time to time, seek
We may in the future become involved in lawsuits to protect or enforce our intellectual property rights. An adverse result in any litigation proceeding could harm our business. In any lawsuit we bring to enforce our intellectual property rights, a court may refuse to stop the other party from using the technology at issue on grounds that our intellectual property rights do not cover the technology in question. If we initiate legal proceedings against a third party to enforce a patent covering a product, the defendant could counterclaim that such patent is invalid or unenforceable. In patent litigation in the United States, defendant counterclaims alleging invalidity or unenforceability are commonplace. Grounds for a validity challenge could be an alleged failure to meet any of several statutory requirements, including lack of novelty, obviousness, or
The outcome following legal assertions of invalidity and unenforceability is unpredictable. With respect to the validity question, for example, we cannot be certain that there is no invalidating prior art, of which we and the patent examiner were unaware during prosecution. If a third party were to prevail on a legal assertion of invalidity or unenforceability, we would lose at least part, and perhaps all, of the patent protection on our products. Such a loss of patent protection would have a material adverse impact on our business, financial condition, results of operations, and prospects.
Because of the substantial amount of discovery required in connection with intellectual property litigation, there is a risk that some of our confidential information could be compromised by disclosure during litigation. There could also be public announcements of the results of hearing, motions, or other interim developments. If securities analysts or investors perceive these results to be negative, it could have a material adverse effect on the price of shares of our common stock. Even if we ultimately prevail, a court may decide not to grant an injunction against further infringing activity and instead award only monetary damages, which may not be an adequate remedy. Furthermore, the monetary cost of such litigation and the diversion of the attention of our management could outweigh any
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benefit we receive as a result of the proceedings. Uncertainties resulting from the initiation and continuation of patent litigation or other proceedings could have a material adverse effect on our business.
If we infringe, misappropriate or otherwise violate the intellectual property rights of third parties or are subject to an intellectual property infringement or misappropriation claim, our ability to grow our business may be severely limited and our business could be adversely affected.
We may in the future be the subject of patent or other litigation. Our products and services may infringe, or third parties may claim that they infringe, intellectual property rights covered by patents or patent applications under which we do not hold licenses or other rights. Third parties may own or control these patents and patent applications in the United States and abroad. These third parties could bring claims against us that would cause us to incur substantial expenses and, if successfully asserted against us, could cause us to pay substantial damages. Further, if a patent infringement or other intellectual property-related lawsuit were brought against us, we could be forced to stop or delay production or sales of the product that is the subject of the suit. From time to time, we have received and may in the future receive letters from third parties drawing our attention to their
Changes in U.S. patent laws may limit our ability to obtain, defend and/or enforce our patents.
Any patent reform legislation could increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents. For example, the Leahy-Smith America Invents Act (the “Leahy-Smith Act”) included a number of significant changes to U.S. patent law. These include provisions that affected the way patent applications are prosecuted and also affect patent litigation. The USPTO developed regulations and procedures to govern administration of the Leahy-Smith Act, and many of the substantive changes to patent law associated with the Leahy-Smith Act, and in particular, the first to file provisions, which became effective on March 16, 2013. The first to file provisions limit the rights of an inventor to patent an invention if not the first to file an application for patenting that invention, even if such invention was the first invention. Accordingly, it is not clear what, if any, impact the Leahy-Smith Act will have on the operation of our business.
However, the Leahy-Smith Act and its implementation could increase the uncertainties and costs surrounding the enforcement and defense of our issued patents. For example, the Leahy-Smith Act provides that an administrative tribunal known as the Patent Trial and Appeals Board (“PTAB”) provides a venue for challenging the validity of patents at a cost that is much lower than district court litigation and on timelines that are much faster. Although it is not clear what, if any, long-term impact the PTAB proceedings will have on the operation of our business, the initial results of patent challenge proceedings before the PTAB since its inception in 2013 have resulted in the invalidation of many U.S. patent claims. The availability of the PTAB as a lower-cost, faster and potentially more potent tribunal for challenging patents could increase the likelihood that our own patents will be challenged, thereby increasing the uncertainties and costs of maintaining and enforcing them.
We may be subject to claims that we or our employees have misappropriated the intellectual property of a third party, including trade secrets or
Many of our employees and consultants were previously employed at or engaged by other medical device companies, including our competitors or potential competitors. Some of these employees, consultants and contractors may have executed proprietary rights,
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that are essential to our products, if such technologies or features are found to incorporate or be derived from the trade secrets or other proprietary information of the former employers. An inability to incorporate technologies, features or other intellectual property that are important or essential to our products could have a material adverse effect on our business and competitive position, and may prevent us from selling our products. In addition, we may lose valuable intellectual property rights or personnel. Even if we are successful in defending against these claims, litigation could result in substantial costs and could be a distraction to management. Any litigation or the threat thereof may adversely affect our ability to hire employees or contract with independent sales representatives. A loss of key personnel or their work product could hamper or prevent our ability to commercialize our products, which could materially and adversely affect our business, financial condition, operating results, cash flows and prospects.
If we fail to execute invention assignment agreements with our employees and contractors involved in the development of intellectual property or are unable to protect the confidentiality of our trade secrets, the value of our products and our business and competitive position could be harmed.
In addition to patent protection, we also rely on protection of copyright, trade secrets,
In addition to contractual measures, we try to protect the confidential nature of our proprietary information using commonly accepted physical and technological security measures. Such measures may not, for example, in the case of misappropriation of a trade secret by an employee or third party with authorized access, provide adequate protection for our proprietary information. Our security measures may not prevent an employee or consultant from misappropriating our trade secrets and providing them to a competitor, and recourse we take against such misconduct may not provide an adequate remedy to protect our interests fully. Unauthorized parties may also attempt to copy or reverse engineer certain aspects of our products that we consider proprietary. Enforcing a claim that a party illegally disclosed or misappropriated a trade secret can be difficult, expensive and time-consuming, and the outcome is unpredictable. Even though we use commonly accepted security measures, trade secret violations are often a matter of state law, and the criteria for protection of trade secrets can vary among different jurisdictions. In addition, trade secrets may be independently developed by others in a manner that could prevent legal recourse by us. We also have agreements with our employees, consultants and third parties that obligate them to assign their inventions to us; however, these agreements may not be self-executing, not all employees or consultants may enter into such agreements, or employees or consultants may breach or violate the terms of these agreements, and we may not have adequate remedies for any such breach or violation. If any of our intellectual property or confidential or proprietary information, such as our trade secrets, were to be disclosed or misappropriated, or if any such information was independently developed by a competitor, it could have a material adverse effect on our competitive position, business, financial condition, results of operations, and prospects.
We may be unable to enforce our intellectual property rights throughout the world.
The laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the United States. Many companies have encountered significant problems in protecting and defending intellectual property rights in certain foreign jurisdictions. This could make it difficult for us to stop infringement of our foreign patents, if obtained, or the misappropriation of our other intellectual property rights. For example, some foreign countries have compulsory licensing laws under which a patent owner must grant licenses to third parties. In addition, some countries limit the enforceability of patents against third parties, including government agencies or government contractors. In these countries, patents may provide limited or no benefit. Patent protection must ultimately be sought on a
Proceedings to enforce our patent rights in foreign jurisdictions could result in substantial costs and divert our efforts and attention from other aspects of our business. Accordingly, our efforts to protect our intellectual property rights in such countries may be inadequate. In addition, changes in the law and legal decisions by courts in the United States and foreign countries may affect our ability to obtain adequate protection for our technology and the enforcement of our intellectual property.
Actual or perceived failures to comply with applicable data privacy and security laws, regulations, policies, standards, contractual obligations and other requirements related to data privacy and security and changes to such laws, regulations, standards, policies and contractual obligations could adversely affect our business, financial condition and results of operations.
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The global data protection landscape is rapidly evolving, and there has been an increasing focus on privacy and data protection issues with the potential to affect our business. We are or may become subject to numerous state, federal and foreign laws, requirements and regulations governing the collection, transmission, use, disclosure, storage, retention and security of personal and personally-identifying information, such as information that we may collect in connection with conducting our business in the United States and abroad. Implementation standards and enforcement practices are likely to remain uncertain for the foreseeable future, and we cannot yet determine the impact future laws, regulations, standards or perception of their requirements may have on our business. This evolution may create uncertainty in our business, affect our ability to operate in certain jurisdictions or to collect, store, transfer use and share personal information, necessitate the acceptance of more onerous obligations in our contracts, result in liability or impose additional costs on us. The cost of compliance with these laws, regulations and standards is high and is likely to increase in the future. Any failure or perceived failure by us to comply with federal, state or foreign laws or regulation, our internal policies and procedures or our contracts governing our processing of personal information could result in negative publicity, government investigations and enforcement actions, fines, imprisonment of company officials and public censure, claims by third parties, damage to our reputation and loss of goodwill, any of which could have a material adverse effect on our business, financial condition and results of operations.
In the ordinary course of our business, we collect and store sensitive data, including protected health information (“PHI”), personally identifiable information (“PII”), intellectual property and proprietary business information owned or controlled by ourselves or our customers, third-party payors and other parties. We also collect and store sensitive data of our employees and contractors. We manage and maintain our applications and data utilizing cloud-based data centers for PII. We utilize external security and infrastructure vendors to manage parts of our data centers.
As our operations and business grow, we are and may become subject to or affected by new or additional data protection laws and regulations and face increased scrutiny or attention from regulatory authorities. In the United States, HIPAA establishes, among other things, privacy and security standards that limit the use and disclosure of PHI, and imposes certain obligations, including mandatory contractual terms, with respect to safeguarding the privacy, security and transmission of PHI by covered entities, such as health plans, healthcare clearinghouses and healthcare providers, as well as their business associates that perform certain services involving the use or disclosure of PHI, and their covered subcontractors. HIPAA requires covered entities and their business associates to develop and maintain certain policies and procedures with respect to PHI that is used or disclosed. Further, in the event of a breach of unsecured protected health information, HIPAA requires covered entities to notify each individual whose PHI is breached as well as federal regulators and, in some cases, the media. Certain states have also adopted comparable privacy and security laws and regulations, some of which may be more stringent than HIPAA. Such laws and regulations will be subject to interpretation by various courts and other governmental authorities, thus creating potentially complex compliance issues for us and our future customers and strategic partners. Determining whether protected health information has been handled in compliance with applicable privacy standards and our contractual obligations can be complex and may be subject to changing interpretation. If we are unable to properly protect the privacy and security of PHI, we could be found to have breached our contracts. Further, if we fail to comply with applicable privacy laws, including applicable privacy and security standards, we could face civil and criminal penalties. The U.S. Department of Health and Human Services (“HHS”), has the discretion to impose penalties without attempting to resolve violations through informal means. HHS enforcement activity can result in financial liability and reputational harm, and responses to such enforcement activity can consume significant internal resources, each of which could have a material adverse effect on our business financial condition, results of operations or prospects.
In addition, the California Consumer Privacy Act (“CCPA”), which took effect on January 1, 2020, creates individual privacy rights for California consumers and increases the privacy and security obligations of entities handling certain personal information. The CCPA provides for civil penalties for violations, as well as a private right of action for data breaches that is expected to increase data breach litigation. The CCPA may increase our compliance costs and potential liability, and many similar laws have been proposed at the federal level and in other states. Further, the CPRA recently passed in California Privacy Rights Act (the “CPRA”), which will imposegenerally went into effect on January 1, 2023, imposes additional data protection obligations on covered businesses, including additional consumer rights processes, limitations on data uses, new audit requirements for higher risk data, and opt outs for certain uses of sensitive data. It will also createcreated a new California data protection agency authorized to issue substantive regulations and could result in increased privacy and information security enforcement. The majority of the provisions will go into effect on January 1, 2023,CCPA and additionalCPRA may increase our compliance investmentcosts and potential business process changes may be required.liability, and many similar laws have been proposed at the federal level and in other states. In the event that we are subject to or affected by HIPAA, the CCPA, the CPRA or other domestic privacy and data protection laws, any liability from failure to comply with the requirements of these laws could adversely affect our financial condition. Similar laws have passed in Virginia, Connecticut, Colorado and Utah, and have been proposed in other states and at the federal level, reflecting a trend toward more stringent privacy legislation in the United States. The enactment of such laws could have potentially conflicting requirements that would make compliance challenging. We may need to invest substantial resources in putting in place policies and procedures to comply with these evolving state laws.
In addition, state attorneys general are authorized to bring civil actions seeking either injunctions or damages in response to violations that threaten the privacy of state residents. We cannot be sure how these regulations will be interpreted, enforced or applied to our operations. In addition to the risks associated with enforcement activities and potential contractual liabilities, our ongoing efforts to comply with evolving laws and regulations at the federal and state level may be costly and require ongoing modifications to our policies, procedures and systems.
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Data protection laws are evolving globally and may add additional compliance costs and legal risks to our operations. We are subject to the GDPR, which went into effect in May 2018 and which imposes obligations on companies that operate in our industry with respect to the processing of personal data and the cross-border transfer of such data. The GDPR imposes onerous accountability obligations requiring data controllers and processors to maintain a record of their data processing and policies. If our or our partners’ or service providers’ privacy or data security measures fail to comply with the GDPR requirements, we may be subject to litigation, regulatory investigations, enforcement notices requiring us to change the way we use personal data and/or fines of up to 20 million Euros or up to 4% of the total worldwide annual turnover of the preceding financial year, whichever is higher, as well as compensation claims by affected individuals, negative publicity, reputational harm and a potential loss of business and goodwill. Further, as of January 1, 2021, impacted companies have to comply with the GDPR and the UK GDPR, which, together with the amended UK Data Protection Act 2018, retains the GDPR in UK national law, the latter regime having the ability to separately fine up to the greater of £17.5 million or 4% of global turnover. While we continue to address the implications of the recent changes to European data privacy regulations, data privacy remains an evolving landscape at both the domestic and international level, with new regulations coming into effect and continued legal challenges, and our efforts to comply with the evolving data protection rules may be unsuccessful. It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our practices. Accordingly, we must devote significant resources to understanding and complying with this changing landscape.
Although we work to comply with applicable laws, regulations and standards, our contractual obligations and other legal obligations, these requirements are evolving and may be modified, interpreted and applied in an inconsistent manner from one jurisdiction to another, and may conflict with one another or other legal obligations with which we must comply. Any failure or perceived failure by us or our employees, representatives, contractors, consultants or other third parties to comply with such requirements or adequately address privacy and security concerns, even if unfounded, could result in additional cost and liability to us, damage our
Failure to comply with the U.S. Foreign Corrupt Practices Act, economic and trade sanctions regulations and similar laws could subject us to penalties and other adverse consequences.
We are subject to the FCPA and similar regulations in other countries, as well as other laws in the United States and elsewhere that prohibit improper payments or offers of payments to foreign governments and their officials and political parties for the purpose of obtaining or retaining business. Certain suppliers of our product components are located in countries known to experience corruption. Business activities in these countries create the risk of unauthorized payments or offers of payments by one of our employees, contractors or agents that could be in violation of various laws, including the FCPA and anti-bribery laws in these countries, even though these parties are not always subject to our control. While we have implemented policies and procedures designed to discourage these practices by our employees, consultants and agents and to identify and address potentially impermissible transactions under such laws and regulations, we cannot assure you that all of our employees, consultants and agents will not take actions in violation of our policies, for which we may be ultimately responsible.
We are also subject to certain economic and trade sanctions programs that are administered by the Department of Treasury’s Office of Foreign Assets Control which prohibit or restrict transactions to or from or dealings with specified countries, their governments and in certain circumstances, their nationals, and with individuals and entities that are specially designated nationals of those countries, narcotics traffickers and terrorists or terrorist organizations.
Failure to comply with any of these laws and regulations or changes in this regulatory environment, including changing interpretations and the implementation of new or varying regulatory requirements by the government, may result in significant financial penalties or reputational harm, which could adversely affect our business, financial condition and results of operations.
Risks relating to our common stock
We have identified material weaknesses in our internal control over financial reporting and entity level controls. If our remediation of the material weaknesses is not effective, or if we experience additional material weaknesses in the future or otherwise fail to maintain an effective system of internal controls in the future, we may not be able to accurately or timely report our financial condition or results of operations, which may adversely affect investor confidence in us and, as a result, the value of our common stock.
In connection with the preparation of our financial statements at the time of our IPO and through the financial reporting period ended December 31, 2022, we identified material weaknesses in our internal control over financial reporting and our entity level controls. A material weakness is a deficiency, or combination of deficiencies, in internal controls such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis.
With respect to the material weakness related to internal control over financial reporting, we have implemented, and are in the process of reviewing corrective actions taken to improve our internal control over financial reporting to remediate this material weakness,
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including (i) the hiring of additional qualified supervisory resources and finance department employees, and (ii) the engagement of additional technical accounting consulting resources.
With respect to the material weakness related to entity level controls related to a lack of sufficient qualified healthcare industry compliance and risk management resources, including those necessary to provide appropriate oversight, monitor compliance, and to identify and mitigate risks with respect to the financial reporting and disclosures of our operations, we have expended, and intend to continue to expend, considerable time and effort to enhance our compliance and risk management processes with respect to our operations in the healthcare industry to remediate this material weakness, including the hiring of additional qualified personnel, and the engagement of additional specialized consulting resources.
We cannot assure you that the measures we intend to take will be sufficient to remediate the material weaknesses we have identified or avoid potential future material weaknesses. While we believe that our efforts will enhance our internal control, remediation of the material weaknesses will require further validation and testing of the design and operating effectiveness of internal controls over a sustained period of financial reporting cycles, and we cannot assure you that we have identified all, or that we will not in the future have additional, material weaknesses.
If we are unable to implement and maintain effective internal control over financial reporting in the future, we may not be able to accurately report our financial condition or results of operations which may adversely affect investor confidence in us and, as a result, the value of our common stock.
We are subject to Section 404 of the Sarbanes-Oxley Act, or Section 404, and the related rules of the SEC, which generally require our management to furnish a report on the effectiveness of our internal control over financial reporting. The process of designing, implementing and testing the internal control over financial reporting required to comply with this obligation is time-consuming, costly and complicated. If we fail to remediate identified material weaknesses or identify additional material weaknesses in our internal control over financial reporting, if we are unable to comply with the requirements of Section 404 of the Sarbanes-Oxley Act in a timely manner, or if we are unable to assert that our internal control over financial reporting is effective, investors may lose confidence in the accuracy and completeness of our financial reports and the market price of our common stock could decline, and we could also become subject to investigations by the stock exchange on which our common stock is listed, the SEC or other regulatory authorities, which could require additional financial and management resources. Because we re-qualified as a smaller reporting company and we have less than $100 million in annual revenue, we are a non-accelerated filer and are no longer required to comply with the auditor attestation requirements regarding the effectiveness of our internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act until we become an accelerated filer or large accelerated filer. These exemptions and reduced disclosures in our SEC filings due to our status as a smaller reporting company may make it harder for investors to analyze our results of operations and financial prospects. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.
Raising additional capital may cause dilution to our stockholders, restrict our operations or require us to relinquish rights to our technologies or products.
Since our inception, our operations have been financed primarily by net proceeds from the sale of our convertible preferred stock and common stock, indebtedness and revenue from the sales of our products. We anticipate our future capital requirements will be substantial and that we will need to raise significant additional capital to fund our operations through equity or debt financing, or some combination thereof.
If we are unable to raise additional funding to meet our operational needs, we will be forced to limit or cease our operations. We regularly consider fundraising opportunities and may decide, from time to time, to raise capital based on various factors, including market conditions and our plans of operation. We may seek funds through borrowings or through additional rounds of financing, including private or public equity or debt offerings. Additional capital may not be available to us on acceptable terms on a timely basis, or at all. If adequate funds are not available, or if the terms of potential funding sources are unfavorable, our business and our ability to develop our technology and our products would be harmed. If we raise additional funds by issuing equity securities, our stockholders may suffer dilution and the terms of any financing may adversely affect the rights of our stockholders. In addition, as a condition to providing additional funds to us, future investors may demand, and may be granted, rights superior to those of existing stockholders. Debt financing, if available, is likely to involve restrictive covenants limiting our flexibility in conducting future business activities, and, in the event of insolvency, debt holders would be repaid before holders of our equity securities receive any distribution of our corporate assets. We also could be required to seek funds through arrangements with partners or others that may require us to relinquish rights or jointly own some aspects of our technologies or products that we would otherwise pursue on our own.
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We incur significantly increased costs and are subject to additional regulations and requirements as a result of becoming a public company, which could lower our profits or make it more difficult to run our business.
As a public company, we incur significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements. We also have incurred and will continue to incur costs associated with the Sarbanes-Oxley Act, and related rules implemented by the SEC and the exchange our securities are listed on. The expenses generally incurred by public companies for reporting and corporate governance purposes have been increasing. We expect these rules and regulations to increase our legal and financial compliance costs and to make some activities more time-consuming and costly, although we are currently unable to estimate these costs with any degree of certainty. These laws and regulations also could make it more difficult or costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. These laws and regulations could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, on our board committees or as our executive officers. Furthermore, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our common stock, fines, sanctions, other regulatory action and potentially civil litigation.
If our operating and financial performance in any given period does not meet any guidance that we provide to the public, the market price of our common stock may decline.
Any public guidance we provided regarding our expected operating and financial results for future periods is comprised of forward-looking statements subject to the risks and uncertainties described in this Annual Report on Form 10-K and in our other public filings and public statements. Our actual results may not always be in line with or exceed any guidance we provide, especially in times of economic uncertainty. If our operating or financial results for a particular period do not meet any guidance we provide or the expectations of investment analysts, or if we reduce our guidance for future periods, the market price of our common stock may decline. In September 2021, we withdrew our financial guidance for the fiscal year ended December 31, 2021 as a result of uncertainties arising with respect to the DOJ investigation and claims audits (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—DOJ investigation and settlement and claims audits” for more information). While we have since provided some limited financial guidance, we cannot be certain if or when we will resume providing more fulsome financial guidance.
Our principal stockholder, an entity affiliated with Patient Square, owns a significant percentage of our stock and will be able to exert significant control over matters subject to stockholder approval.
As of December 31, 2022, our principal stockholder, an entity affiliated with Patient Square, held approximately 76.3% of our outstanding voting stock. As a result of this ownership position, Patient Square may be able to determine all matters requiring stockholder approval. For example, Patient Square may be able to control elections of directors, amendments of our organizational documents, or approval of any merger, sale of assets, or other major corporate transaction. This may prevent or discourage unsolicited acquisition proposals or offers for our common stock that you may feel are in your best interest as one of our stockholders.
We have no current plans to pay cash dividends on our common stock; as a result, you may not receive any return on investment unless you sell your common stock for a price greater than that which you paid for it.
We have never declared or paid cash dividends on our common stock, and we do not currently intend to pay any cash dividends on our common stock in the foreseeable future. We currently intend to retain all available funds and any future earnings to fund the development and expansion of our business. Any future determination related to dividend policy will be made at the discretion of our board of directors, subject to applicable laws, and will depend upon, among other factors, our results of operations, financial condition, contractual restrictions and capital requirements. Additionally, our ability to pay cash dividends on our common stock may be limited by the terms of any future debt or preferred securities we issue or any future credit facilities we enter into. As a result, you may not receive any return on an investment in our common stock unless you sell your common stock for a price greater than that which you paid for it.
We are a “controlled company” within the meaning of the Nasdaq rules and, as a result, qualify for, and rely on, certain exemptions from certain corporate governance requirements.
Patient Square controls a majority of the voting power of our outstanding common stock. As a result, we are a “controlled company” within the meaning of the Nasdaq corporate governance standards. A company of which more than 50% of the voting power is held by an individual, a group or another company is a “controlled company” within the meaning of the Nasdaq rules and may elect not to comply with certain corporate governance requirements of Nasdaq, including:
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We intend to rely on some or all of the exemptions listed above for so long as we are eligible to do so. To the extent we utilize these exemptions, we will not have a majority of independent directors and our nominating and corporate governance and compensation committees will not consist entirely of independent directors. As a result, our board of directors and those committees may have more directors who do not meet Nasdaq’s independence standards than they would if those standards were to apply. The independence standards are intended to ensure that directors who meet those standards are free of any conflicting interest that could influence their actions as directors. Accordingly, our stockholders may not have the same protections afforded to stockholders of companies that are subject to all of the corporate governance requirements of Nasdaq.
Sales of a substantial number of shares of our common stock in the public market could cause our stock price to fall.
If our existing stockholders sell, or indicate an intention to sell, substantial amounts of our common stock in the public market, the trading price of our common stock could decline. On a post-reverse stock split basis, we had a total of 20,726,965 shares of common stock outstanding as of December 31, 2022.
Patient Square, which holds approximately 76.3% of our common stock, and maintains rights with respect to the registration of their shares under the Securities Act. On December 16, 2022, the Company filed a registration statement on Form S-1 (File No. 333-268859) to register for resale up to 15,821,299 shares held by Patient Square (as amended, the “PSC Resale Registration Statement”), representing the entirety of Patient Square’s holdings in the Company’s common stock as of December 31, 2022. The PSC Resale Registration Statement became effective on February 13, 2023. Registration of these shares under the Securities Act has resulted in the shares becoming freely tradable without restriction under the Securities Act, except for shares purchased by affiliates. Any sales of these securities by Patient Square could have a material adverse effect on the trading price of our common stock.
Provisions in our charter documents and under Delaware law could discourage a takeover that stockholders may consider favorable and may lead to entrenchment of management.
Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could delay or prevent changes in control or changes in our management without the consent of our board of directors. These provisions include:
We are also subject to the anti-takeover provisions contained in Section 203 of the Delaware General Corporation Law. Under Section 203, a corporation may not, in general, engage in a business combination with any holder of 15% or more of its capital stock unless the holder has held the stock for three years or, among other exceptions, the board of directors has approved the transaction.
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Claims for indemnification by our directors, officers and other employees or agents may reduce our available funds to satisfy successful third-party claims against us and may reduce the amount of money available to us.
Our amended and restated certificate of incorporation and amended and restated bylaws provide that we will indemnify our directors and officers, in each case to the fullest extent permitted by Delaware law.
In addition, as permitted by Section 145 of the Delaware General Corporation Law, our amended and restated bylaws and our indemnification agreements that we have entered into with our directors, officers and certain other employees provide that:
Our amended and restated certificate of incorporation and amended and restated bylaws provide that the Court of Chancery of the State of Delaware will be the exclusive forum for certain disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.
Our amended and restated certificate of incorporation and amended and restated bylaws provide that the Court of Chancery of the State of Delaware (or, in the event that the Court of Chancery does not have jurisdiction, the federal district court for the District of Delaware or other state courts of the State of Delaware) is the exclusive forum for any derivative action or proceeding brought on our behalf, any action asserting a claim of breach of fiduciary duty, any action asserting a claim against us arising pursuant to the Delaware General Corporation Law, our amended and restated certificate of incorporation or our amended and restated bylaws, or any action asserting a claim against us that is governed by the internal affairs doctrine; provided that, the exclusive forum provision will not apply to suits brought to enforce any liability or duty created by the Exchange Act, or any other claim for which the federal courts have exclusive jurisdiction; and provided further that, if and only if the Court of Chancery of the State of Delaware dismisses any such action for lack of subject matter jurisdiction, such action may be brought in another state or federal court sitting in the State of Delaware. Our amended and restated certificate of incorporation and amended and restated bylaws also provide that the federal district courts of the United States of America will be the exclusive forum for the resolution of any complaint asserting a cause of action against us or any of our directors, officers, employees or agents and arising under the Securities Act. Nothing in our amended and restated certificate of incorporation or amended and restated bylaws precludes stockholders that assert claims under the Exchange Act from bringing such claims in state or federal court, subject to applicable law.
We believe these provisions may benefit us by providing increased consistency in the application of Delaware law and federal securities laws by chancellors and judges, as applicable, particularly experienced in resolving corporate disputes, efficient administration of cases on a more expedited schedule relative to other forums and protection against the burdens of multi-forum litigation. However, this choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or any of our directors, officers, other employees or stockholders, which may discourage lawsuits with respect to such claims, although our stockholders will not be deemed to have waived our compliance with federal securities laws and the rules and regulations thereunder. Furthermore, the enforceability of similar choice of forum provisions in other companies’ certificates of incorporation has been challenged in legal proceedings, and it is possible that a court could find these types of provisions to be inapplicable or unenforceable. While the Delaware courts have determined that such choice of forum provisions are facially valid, a stockholder may nevertheless seek to bring a claim in a venue other than those designated in the exclusive forum provisions, and there can be no assurance that such provisions will be enforced by a court in those other jurisdictions. If a court were to find the choice of forum provision that will be contained in our amended and restated certificate of incorporation and amended and
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restated bylaws to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.
If securities analysts publish negative evaluations of our stock or stop publishing research or reports about our business, the price of our stock could decline.
The trading market for our common stock relies in part on the research and reports that industry or financial analysts publish about us or our business. We currently have limited research coverage by financial analysts. Some of the analysts who previously covered the Company have discontinued coverage, and certain analysts have downgraded their evaluation of our stock. For example, certain of our analysts downgraded our common stock following our announcement of the DOJ investigation and claims audits (see “Management’s Discussion and Analysis of Financial Condition and Results of Operations— DOJ investigation and settlement and claims audits”), which may have contributed to a significant decline in the price of our common stock. If any of the analysts who continue to cover or cover us in the future downgrade their evaluation of our common stock or publishes inaccurate or unfavorable research about our business, our common stock price may decline. If additional analysts cease to cover our stock, we could lose visibility in the market for our stock, which in turn could cause our stock price to decline.
General risk factors
Engaging in acquisitions or strategic partnerships may increase our capital requirements, dilute our stockholders, cause us to incur debt or assume contingent liabilities and subject us to other risks.
As part of our business strategy, we may acquire companies or businesses, enter into strategic partnerships and joint ventures and make investments to further our business. Risks associated with these transactions include the following, any of which could adversely affect our revenue, gross margin, profitability, cash flows and financial condition:
In addition, in connection with these acquisitions or strategic partnerships, we may issue dilutive securities, assume or incur debt obligations, incur large one-time expenses and acquire intangible assets that could result in significant future amortization expense. Moreover, we may not be able to locate suitable acquisition or partnership opportunities, and even if we do locate such opportunities we may not be able to successfully bid for or obtain them due to competitive factors or lack of sufficient resources. This inability could impair our ability to grow or obtain access to technology or products that may be important to the development of our business.
We experience seasonality in our business, which may cause fluctuations in our financial results.
In the past we have experienced, and we may continue to experience, seasonality in our business, with higher sales volumes in quarters when we commercially launch new products and in the fourth calendar quarter as a result of holiday promotional activity. However, since our public disclosure of the DOJ investigation and our related decision to temporarily stop accepting insurance benefits as a method of direct payment between December 8, 2021 and September 15, 2022, we have experienced and may continue to experience a material decline in gross systems shipped. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—DOJ investigation and settlement and claims audits” for more information. As a result, seasonal factors did not have a material impact on our results of operations for the three months and year ended December 31, 2022. Negative publicity, including in relation to the DOJ investigation, the claims audits, and other legal proceedings has and could continue to harm our reputation and brand and diminish consumer confidence in our products, which may further impact any seasonal trends in our business.
Because of these fluctuations, among other factors, it is possible that in future periods our operating results will fall below the expectations of securities analysts or investors, in which case the market price of our stock would likely decrease. These fluctuations,
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among other factors, also mean that our operating results in any particular period may not be relied upon as an indication of future performance.
Our effective tax rate may vary significantly from period to period.
Various internal and external factors may have favorable or unfavorable effects on our future effective tax rate. These factors include, but are not limited to, changes in tax laws both within and outside the United States, regulations and/or rates, structural changes in our business, new or changes to accounting pronouncements, non-deductible goodwill impairments, changing interpretations of existing tax laws or regulations, changes in the relative proportions of revenue and income before taxes in the various jurisdictions in which we operate that have differing statutory tax rates, the future levels of tax benefits of equity-based compensation, changes in overall levels of pretax earnings or changes in the valuation of our deferred tax assets and liabilities. Additionally, we could be challenged by state and local tax authorities as to the propriety of our sales tax compliance, and our results could be materially impacted by these compliance determinations.
In addition, our effective tax rate may vary significantly depending on our stock price. The tax effects of the accounting for share-based compensation may significantly impact our effective tax rate from period to period. In periods in which our stock price is higher than the grant price of the share-based compensation vesting in that period, we will recognize excess tax benefits that will decrease our effective tax rate. In periods in which our stock price is lower than the grant price of the share-based compensation vesting in that period, our effective tax rate may increase. The amount and value of share-based compensation issued relative to our earnings in a particular period will also affect the magnitude of the impact of share-based compensation on our effective tax rate. These tax effects are dependent on our stock price, which we do not control, and a decline in our stock price could significantly increase our effective tax rate and adversely affect our financial results.
We are subject to a number of risks related to the credit card and debit card payments we accept.
We accept payments through credit and debit card transactions. For credit and debit card payments, we pay interchange and other fees, which may increase over time. An increase in those fees may require us to increase the prices we charge and would increase our operating expenses, either of which may adversely affect our business, financial condition and results of operations.
If we or our processing vendors fail to maintain adequate systems for the authorization and processing of credit and debit card transactions, it could cause one or more of the major credit card companies to disallow our continued use of their payment products. In addition, if these systems fail to work properly and, as a result, we do not charge our customers’ credit or debit cards on a timely basis, or at all, it could adversely affect our business, financial condition and results of operations.
The payment methods that we offer also subject us to potential fraud and theft by criminals, who are becoming increasingly more sophisticated in exploiting weaknesses that may exist in the payment systems. If we fail to comply with applicable rules or requirements for the payment methods we accept, or if payment-related data is compromised due to a breach, we may be liable for significant costs incurred by payment card issuing banks and other third parties or subject to fines and higher transaction fees, or our ability to accept or facilitate certain types of payments may be impaired. In addition, our customers could lose confidence in certain payment types, which may result in a shift to other payment types or potential changes to our payment systems that may result in higher costs. If we fail to adequately control fraudulent credit card transactions, we may face civil liability, diminished public perception of our security measures and significantly higher card-related costs, each of which could have a material adverse effect on our business, financial condition and results of operations.
We are also subject to payment card association operating rules, certification requirements and rules governing electronic funds transfers, which could change or be reinterpreted to make it more difficult for us to comply. We are required to comply with payment card industry security standards. Failing to comply with those standards may violate payment card association operating rules, federal and state laws and regulations and the terms of our contracts with payment processors. Any failure to comply fully also may subject us to fines, penalties, damages and civil liability, and may result in the loss of our ability to accept credit and debit card payments. Further, there is no guarantee that such compliance will prevent illegal or improper use of our payment systems or the theft, loss or misuse of data pertaining to credit and debit cards, card holders and transactions.
If we are unable to maintain our chargeback rate or refund rates at acceptable levels, our processing vendor may increase our transaction fees or terminate its relationship with us. Any increases in our credit and debit card fees could harm our results of operations, particularly if we elect not to raise our rates for our products to offset the increase. The termination of our ability to process payments on any major credit or debit card would significantly impair our ability to operate our business.
Our information technology systems or those used by our third-party service providers, vendors, strategic partners or other contractors or consultants, may fail or suffer security breaches and other disruptions, which could result in a material disruption of our products and services development programs, compromise sensitive information related to our business or prevent us from
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accessing critical information, potentially exposing us to liability or otherwise adversely affecting our business, financial condition and results of operations.
We collect and maintain information in digital form that is necessary to conduct our business, and we are increasingly dependent on information technology systems and infrastructure to operate our business, including our cloud-based infrastructure, mobile and
Our internal information technology systems and those of our third-party service providers, vendors, strategic partners and other contractors or consultants are vulnerable to attack and damage or interruption from computer viruses and malware (e.g., ransomware), natural disasters, terrorism, war, telecommunication and electrical failures, hacking, cyberattacks, phishing attacks and other social engineering schemes, malicious code, employee theft or misuse, denial or degradation of service attacks, sophisticated nation-state and nation-state-supported actors or unauthorized access or use by persons inside our organization, or persons with access to systems inside our organization. The risk of a security breach or disruption, particularly through cyberattacks or cyber intrusion, including by computer hackers, foreign governments and cyber terrorists, has generally increased as the number, intensity and sophistication of attempted attacks and intrusions from around the world have increased. Russia’s invasion of Ukraine or another war of international dispute (such as, for example, any escalation in geopolitical turmoil between the People’s Republic of China and Taiwan) may cause a general increase in the number and severity of such malicious incidents. As a result of the COVID-19 pandemic, and continued hybrid working environment, we may also face increased cybersecurity risks due to our reliance on internet technology and the number of our employees who are working remotely, which may create additional opportunities for cybercriminals to exploit vulnerabilities. Furthermore, because the techniques used to obtain unauthorized access to, or to sabotage, systems change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques or implement adequate preventative measures. We may also experience security breaches that may remain undetected for an extended period. Even if identified, we may be unable to adequately investigate or remediate incidents or breaches due to attackers increasingly using tools and techniques that are designed to circumvent controls, to avoid detection, and to remove or obfuscate forensic evidence.
The costs to us to investigate and mitigate network security problems, bugs, viruses, worms, malicious software programs, ransomware, and security vulnerabilities could be significant, and while we have implemented security measures to protect our data security and information technology systems from system failure, accident and security breach, our efforts to address these problems may not be successful, and these problems could result in unexpected interruptions, delays, disruption of our development programs and
If a security breach or other incident were to result in the unauthorized access to or unauthorized use, disclosure, release or other processing of personal information, it may be necessary to notify individuals, governmental authorities, supervisory bodies, the media and other parties pursuant to applicable privacy and security laws. For example, the Company retains data that is subject to HIPAA, which contain specific security and notification requirements to which we must adhere. Any security compromise affecting us, our service providers, vendors, strategic partners, other contractors, consultants, or our industry, whether real or perceived, could harm our reputation, erode confidence in the effectiveness of our security measures and lead to regulatory scrutiny. To the extent that any disruption or security breach were to result in a loss of, or damage to, our data or systems, or inappropriate disclosure of confidential or proprietary or personal information, we could incur liability, including litigation exposure, penalties and fines, we could become the subject of regulatory action or investigation, our competitive position could be harmed and the further development and commercialization of our products and services could be delayed. If such an event were to occur and cause interruptions in our operations, it could result in a material disruption of our business. Furthermore, federal, state and international laws and regulations can expose us to enforcement actions and investigations by regulatory authorities, and potentially result in regulatory penalties, fines and significant legal liability, if our information technology security efforts fail. We would also be exposed to a risk of loss or
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litigation and potential liability, which could materially and adversely affect our business, financial condition and results of operations or prospects. Further, any losses, costs or liabilities may not be covered by, or may exceed the coverage limits of, any applicable insurance policies.
International trade disputes could result in tariffs and other protectionist measures that could have a material adverse effect on our business, financial condition and results of operations.
Tariffs could increase the cost of our products and the raw materials that go into making them. These increased costs could adversely impact the gross margin that we earn on our products. Tariffs could also make our products more expensive for customers, which could make our products less competitive and reduce consumer demand. Countries may also adopt other protectionist measures that could limit our ability to offer our products. Political uncertainty surrounding international trade disputes and protectionist measures (including as a result of the escalating conflict between Russia and Ukraine and the various sanctions and export controls being implemented by the international community against Russia)Russia, as well as any escalating geopolitical turmoil between the People’s Republic of China and Taiwan) could also have a negative effect on consumer confidence and spending, which could have a material adverse effect on our business, financial condition and results of operations.
If we are unable to continue to drive consumers to our website, it could cause our revenue to decrease.
Many consumers find our website by searching for hearing aid information through internet search engines or from word-of-mouth and personal recommendations. A critical factor in attracting visitors to our website is how prominently we are displayed in response to search queries. Accordingly, we use search engine marketing as a means to provide a significant portion of our customer acquisition. Search engine marketing includes both paid website visitor acquisition on a cost-per-click basis and visitor acquisition on an unpaid basis, often referred to as organic or algorithmic search.
One method we employ to acquire visitors via organic search is commonly known as search engine optimization (“SEO”). SEO involves developing our website in a way that enables the website to rank high for search queries for which our website’s content may be relevant. We also rely heavily on favorable recommendations from our existing customers to help drive traffic to our website. If our website is listed less prominently or fails to appear in search result listings for any reason, it is likely that we will attract fewer visitors to our website, which could adversely affect our revenue.
Disruptions in internet access, or in cloud-based hosting services from certain third parties, could adversely affect our business, financial condition and results of operations.
As an online business, we are dependent on the internet and maintaining connectivity between ourselves and consumers and sources of internet traffic, such as Google. As consumers increasingly turn to mobile devices, we also become dependent on consumers’ access to the internet through mobile carriers and their systems. Disruptions in internet access, whether generally, in a specific market or otherwise, especially if widespread or
Additionally, we rely on third-party service providers to host our data and to provide services to key aspects of our operations, including production, logistics, delivery and customer services and databases as well as employee and payroll services. We do not control the operations, physical security, or data security of any of these third parties. Despite our efforts to use commercially reasonable diligence in the selection and retention of such third-party providers, such efforts may be insufficient or inadequate to prevent or remediate such risks. Our third-party providers, including our cloud computing providers, may be subject to intrusions, computer viruses, denial-of-service attacks, sabotage, acts of vandalism, acts of terrorism, and other misconduct. They are vulnerable to damage or interruption from power loss, telecommunications failures, fires, floods, earthquakes, hurricanes, tornadoes, and similar events, and they may be subject to financial, legal, regulatory, and labor issues, each of which may impose additional costs or requirements on us or prevent these third parties from providing services to us or our customers on our behalf.
In addition, these third parties may breach their agreements with us, disagree with our interpretation of contract terms or applicable laws and regulations, refuse to continue or renew these agreements on commercially reasonable terms or at all, fail to or refuse to process transactions or provide other services adequately, take actions that degrade functionality, increase prices, impose additional costs or requirements on us or our customers, or give preferential treatment to our competitors. If we are unable to procure alternatives in a timely and efficient manner and on acceptable terms, or at all, we may be subject to business disruptions, losses, or costs to remediate any of these deficiencies. The occurrence of any of the above events could result in reputational damage, legal or regulatory proceedings, or other adverse consequences, which could materially adversely affect our business, financial condition and results of operations.
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Changes in the regulation of the internet could adversely affect our business.
Laws, rules and regulations governing internet communications, advertising and
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Our corporate headquarters are located in San Jose, California. We leased approximately 30,000 square feet of office and laboratory space pursuant to a lease agreement which was effective as of July 30, 2018 and expired on February 28, 2022. We entered into a new lease agreement in September 2021 for approximately 30,000 square feet of office and laboratory space, which we began using as our headquarters starting in February 2022. This lease expires on June 30, 2029 and we may renew the lease term for two additional
We also lease approximately 9,327 square feet of office space, which is primarily used for our customer support operations, in Nashville, Tennessee, pursuant to a lease that expires on March 31, 2023. We believe that our existing facilities are adequate to meet our business requirements for the near-term, and that additional space will be available on commercially reasonable terms, if required.
Item 3. Legal Proceedings.
The information required to be set forth under this Item 3 is incorporated by reference to Note 6 of the Notes to Consolidated Financial Statements included in Part II of this Annual Report on Form
Item 4. Mine Safety Disclosures.
Not applicable.
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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market information for common stock
Our common stock is traded on the Nasdaq Global Select Market under the symbol “EAR”. Public trading of our common stock began on October 16, 2020. Prior to that, there was no public market for our common stock.
Stockholders
As of May 4, 2022,March 20, 2023, there were 7567 holders of record of our common stock. The actual number of stockholders is greater than this number of record holders, and includes stockholders who are beneficial owners, but whose shares are held in street name by brokers and other nominees. This number of holders of record also does not include stockholders whose shares may be held in trust by other entities.
Dividend policy
We have never declared or paid, and do not anticipate declaring or paying in the foreseeable future, any cash dividends on our common stock. Any future determination as to the declaration and payment of dividends, if any, will be at the discretion of our board of directors, subject to applicable laws and will depend on then existing conditions, including our financial condition, operating results, contractual restrictions, capital requirements, business prospects, and other factors our board of directors may deem relevant.
Securities authorized for issuance under equity compensation plans
The following table provides information on our equity compensation plans as of December 31, 2022. Information is included for equity compensation plans approved by our stockholders.
Name |
| Number of securities to be issued upon exercise of outstanding options, warrants and rights |
| Weighted-average exercise price of outstanding options, warrants and rights |
| Number of securities remaining available for future issuance under equity compensation plans | |||||||||
Equity compensation plans approved by security holders(1)(2)(3) |
|
| 485,378 |
| (4) |
| $ | 82.08 |
| (4) |
|
| 272,776 |
| (5) |
Equity compensation plans not approved by security holders |
|
| — |
|
|
|
| — |
|
|
|
| — |
|
|
Total |
|
| 485,378 |
|
|
| $ | 82.08 |
|
|
|
| 272,776 |
|
|
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Use of proceeds from public offering of common stock
On October 20, 2020, we completed our initial public offering (the “IPO”) and issued 9,029,629451,481 shares of our common stock, which includes an additional 1,177,77758,888 shares of common stock purchased by the underwriters pursuant to their option to purchase additional shares, in each case, on a post-reverse stock split basis, at an initial offering price of $18.00$360.0 per share less underwriting discounts and commissions. We received net proceeds from the IPO of approximately $148.5 million, after deducting underwriting discounts and commissions of $11.4 million and offering costs of $2.6 million. None of the expenses associated with the IPO were paid to directors, officers, persons owning 10% or more of any class of equity securities, or to their associates. J.P. Morgan Securities LLC and BofA Securities, Inc. acted as book-running managers for the IPO.
Shares of our common stock began trading on the Nasdaq Global Select Market on October 16, 2020. The offer and sale of the shares were registered under the Securities Act on a registration statement on Form(Registration
All the planned use of proceeds from our IPO ashave been applied in the manner described in the related prospectus filed with the SEC pursuant to Rule 424(b)(4) under the Securities Act. We invested the funds received in cash equivalents and other marketable securities in accordance with our investment policy.
Sales of unregistered securities
None.
Issuer purchases of equity securities
None.
Item 6. [Reserved].
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis of our financial condition and results of operations together with
The following discussion and analysis of our financial condition and results of operations contains forward-looking statements about us and our industry that involve substantial risks, uncertainties and assumptions. All statements other than statements of historical facts contained in this item, including statements regarding factors affecting our business, trends and uncertainties, are forward-looking statements. As a result of many factors, including those factors set forth in the “Risk Factors” section of this Annual Report on Form
Overview
We are a medical device company dedicated to improving the quality of life of people with hearing loss. We developed the Eargo solution to create a hearing aid that consumers actually want to use. Our innovative productproducts and
We believe our Eargo hearing aids are the first ever virtually invisible, rechargeable,completely-in-canal,United States Food and Drug Administration (“FDA”) regulated, exempt Class I or Class II completely in-the-canal, FDA-regulated devices indicated to compensate for mild to moderate hearing loss. Our rapid pace of innovation is enabled by our deep industry and technical expertise across mechanical engineering, product design, audio processing, clinical and hearing science, consumer electronics and embedded software design, and is supported by our strategic intellectual property portfolio.
We market and sell our hearing aids direct to consumersprimarily in a direct-to-consumer format with a personalized, consumer-centric approach. Our commercial organization consists of a talented marketing team with deep experience in consumer-focused brand and performance marketing, a team of inside sales consultants, and a dedicated customer support team that includes audiologists and hearing professionals. We generate revenue from orders processed primarily through our website and over the phone by our sales consultants.
We believe that our differentiated hearing aids and consumer-oriented approach and strong brand have fueled the rapid adoption of our hearing aids and high customer satisfaction, as evidenced by over 95 thousand109,000 Eargo hearing aid systems sold,shipped, net of returns, as of December 31, 2021.
For the year ended December 31, 2022, we generated net revenue of $37.2 million, an increase of $5.1 million from the year ended December 31, 2021. Our gross systems shipped during the year ended December 31, 2022 were 24,247, compared to 45,136 during 2021. The decrease in shipment volume was largely driven by our decision to temporarily stop accepting insurance benefits as a method of direct payment between December 8, 2021 and September 15, 2022. During the year ended December 31, 2021, we recorded adjustments that materially reduced net revenue as discussed in detail below under “—DOJ investigation and settlement and claims audits.”
Our net losses were $157.5 million, $157.8 million $39.9 million and $44.5$39.9 million for the years ended December 31, 2022, 2021 2020 and 2019,2020, respectively. As of December 31, 20212022 and 2020,2021, we had an accumulated deficit of $356.8$514.3 million and $199.1$356.8 million, respectively. We expect to continue to incur losses for the foreseeable future.
DOJ investigation and settlement and claims audits
As previously disclosed, on September 21, 2021, we were informed that we were the target of a criminal investigation by the U.S. Department of Justice (the “DOJ”)DOJ related to insurance reimbursement claims we submitted for reimbursement on behalf of our customers covered by various federal employee health plans under the Federal Employee Health Benefits (“FEHB”) program.program, which is administered by the Office of Personnel Management (the “OPM”). The investigation also pertained to our role in customer reimbursement claim submissions to federal employee health plans (collectively, the “DOJ investigation”). Total payments the Company received from the government in relation to claims submitted under the FEHB program, as subject to the DOJ investigation, net of any product returns and associated refunds, were approximately $44.0million. Also as previously disclosed, our the third-party payor with whom historically we had the largest volume, which is one of the carriers contracted with the OPM under the FEHB program (“largest third-party payorpayor”), conducted an audit of insurance claims for reimbursement claims (“claims”) submitted by us (the “Primary Audit”), which included a review of medical records. We were informed by the third-party payor conducting the Primary Audit that the DOJ was the principal contact related to the subject matter of the Primary Audit. In addition to the Primary Audit, we have been subject to a number of other claims audits of insurance reimbursement claims submitted toby additional third-party payors (collectively with the Primary Audit, the “claims audits”). One of these claims audits doesdid not relate to claims submitted under the FEHB program. On January 4, 2022, the DOJ confirmed to us that the investigation had been referred to the Civil Division of the DOJ and the U.S. Attorney’s Office for the Northern District of Texas and the criminal investigation was no longer active.
On April 29, 2022, we entered into a civil settlement agreement with the U.S. government that resolved the previously disclosed DOJ investigation related to our role in customer reimbursement claim submissions to various federal employee health plans under the FEHB program. We cooperated fully with the DOJ investigation. We deny the allegations in the settlement agreement, and the settlement is not an
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admission of liability by us. The allegations did not pertain to the quality or performance of our product. The settlement agreement provided for our payment of approximately $34.4 million to the U.S. government and resolved allegations that we submitted or caused the submission of claims for payment to the FEHB program using unsupported hearing loss-related diagnostic codes.
The settlement with the U.S. government may not resolve all of the claims audits of insurance reimbursement claimsinitiated by the various third-party payors, and additionally we remain subject to a prepayment review of claims by the payor who conducted the Primary Audit. We will need to work with the government (including the OPM) and third-party payors to potentially validate and establish processes to support any future claims that we may submit for reimbursement, and there are no guarantees that we will be able to arrive at any such acceptable processes or submit any future claims. We do not intend to submit any claims through the FEHB program until we are able to align with the OPM on and establish processes for supporting the submission of these claims.
From the time we learned of the DOJ investigation and until December 8, 2021, we continued to process orders for customers with potential insurance benefits (including FEHB program members) but suspended all claims submission activities and offered affected customers (iswas denied or ultimately not submitted by us to their insurance plan for payment (the “extended right of return”).
From December 8, 2021 until September 15, 2022, we made the decision to stop acceptingdid not accept insurance benefits as a method of direct payment and it is uncertain when, if ever, we will resume accepting insurance benefits as a method of direct payment. While we intend to work with the government and third-party payors at the appropriate time with the objective of validating and establishing processes to support any future claims that we may submit for reimbursement, we may not be able to arrive at acceptable processes or submit any future claims.
We determined that customer transactions using insurance benefits as a method of direct payment occurring subsequent to learningbetween September 21, 2021 (when we learned of the DOJ investigation on September 21,investigation) and December 8, 2021 (when we temporarily stopped accepting insurance benefits as a method of direct payment) did not meet the criteria for revenue recognition under ASC 606. As such,and, as a result, we did not recognize revenue for shipments within that timeframe to customers with potential insurance benefits, substantially all of whom were covered under the FEHB program, subsequent to that date.
We estimatepreviously estimated that a majority of customers with unsubmitted claims as of December 31, 2021 willwould choose to return the hearing aid system if their insurance provider deniesdenied their claim or the claim iswas ultimately not submitted by us for payment, resulting in an increase in expected product returns from suchsales transactions that occurred prior to September 21, 2021. As a result, we2021 and recorded $13.3 million of estimated sales returns as a reduction in revenue in the third quarter of 2021 related to shipments to customers with potential insurance benefits. This has had a negative impact on our revenues forduring the year ended December 31, 2021 and resulted in an increase in our sales returns reserve. Of the $13.8 million sales returns reserve recorded as of December 31, 2021, $11.4 million relates to unsubmitted claims that are included in accounts receivable, net.2021. Returns associated with unsubmitted claims will reduce the sales returns reserve, with a corresponding reduction in the related accounts receivable at the time the product is returned.
We also estimateestimated that, in addition to the customers who choosechose to return their hearing aid systems, a significant number of customers whose claims arewere denied by insurance providerspayors or not submitted by us for payment maywould not pay for or return the hearing aid system. The $9.6 millionsystem, resulting in bad debt expense that was recorded during the year ended December 31, 2021 is primarily based on2021.
During the year ended December 31, 2022, we made the determination not to seek payment for approximately $16.1 million from customers with unsubmitted and unpaid claims. We accounted for this estimatedecision as a pricing concession (the “Pricing Concession”) and, has hadduring the year ended December 31, 2022 recorded a negative impact on$16.1 million reduction to our operating resultsinsurance-related accounts receivable balance along with related reduction to net revenue of $11.6 million and an allowance for credit losses balance of $4.5 million for such unsubmitted and unpaid claims. Further, we simultaneously recorded a decrease in our insurance-related sales return reserve of $11.3 million, with a corresponding increase of $11.3 million to net revenue for the year ended December 31, 2021. Of the $9.62022 related to unsubmitted and unpaid claims. These changes resulted in a decrease in net revenue of $0.3 million recorded to bad debt expense duringfor the year ended December 31, 2021, $5.8 million relates to submitted claims that have been denied or have not been paid and was written off during the year ended December 31, 2021.
On January 5, 2022, the U.S. District Court for the Northern District of California consolidated three purported securities class actions brought against the Company (the(as consolidated, the “Securities Class Action”). WhileOn May 20, 2022, the lead plaintiffs have not yetin the Securities Class Action filed a consolidated amended complaint, the complaints of the individual lawsuits filed prior to the consolidationwhich generally allegedalleges that certain of the Company’s disclosures about its business, operations and prospects, including reimbursementsreimbursement from third-party payors, violated federal securities laws. On December 3, 2021, a putative stockholderDefendants filed a motion to dismiss the consolidated amended complaint on July 29, 2022. The Court granted the defendants’ motion to dismiss on February 14, 2023, and the plaintiffs have until March 16, 2023, to file a second amended complaint.
On August 4, 2022, the U.S. District Court for the Northern District of California consolidated two verified shareholder derivative complaint purportedly on the Company’s behalfcomplaints brought against certain of our executive officers and current and former members of the Company’s Boardour board of Directors anddirectors (as consolidated, the Company as nominal defendant (the “Derivative Action”), alleging (among other things) that. The court stayed the defendants breached their fiduciary duties by allegedly failingconsolidated Derivative Action until the resolution of the motion to implement and maintain an effective system of internal controls related todismiss the Company’s financial reporting, public disclosures, and compliance with laws, rules, and regulations governing the business.Securities Class Action. See Note 6 of the Notes to Consolidated Financial Statements included in this Annual Report on Form
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As a result of the uncertainty created by the DOJ investigation and the claims audits, we took certain actions including, but not limited to:
Patient Square Capital Investment
On June 24, 2022, after reviewing all available alternatives to secure the funding needed to support our ongoing operations and pursuit of our business strategies, and a potential sale of the Company, we entered into an agreement (the “Note Purchase Agreement”) with PSC Echo, LP (the “PSC Stockholder”), an affiliate of Patient Square Capital (“Patient Square”), and Drivetrain Agency Services, LLC, as administrative agent and collateral agent. Pursuant to the Note Purchase Agreement, we issued approximately $105.5 million in two tranches of senior secured convertible notes (the “Notes”) and agreed to conduct a rights offering for an aggregate of 18.75 million shares of common stock to stockholders as of a record date determined by our Board, at an offering price of $10.0 per share of common stock (the “Rights Offering”). Pursuant to the Rights Offering, which closed on November 23, 2022, we sold an aggregate of approximately 2.9 million shares to our existing stockholders, from which we received net proceeds of $27.6 million, and, in accordance with the terms of the Note Purchase Agreement, the Notes converted into 15,821,299 shares of our common stock (the “Conversion Shares”), in each case, on a post-reverse stock split basis, representing approximately 76.3% of our outstanding common stock as of the date of conversion.
In connection with the Note Purchase Agreement, we had also entered into an Investors’ Rights Agreement with the PSC Stockholder, pursuant to which, among other things, the PSC Stockholder has the right to nominate a number of directors to our Board that is proportionate to the PSC Stockholder’s ownership of the Company, rounded up to the nearest whole number (and which shall in no event be less than one). As a result, following the closing of the Rights Offering and the conversion of the Notes, the PSC Stockholder has the right to nominate six directors to our Board. The PSC Stockholder exercised its right to nominate three directors to the Board, Trit Garg, M.D., Karr Narula and Justin Sabet-Peyman, in December 2022.
As of March 20, 2023, the PSC Stockholder held 15,821,299 shares, representing approximately 76.3% of our outstanding common stock. As a result of Patient Square’s ownership position, we are considered a “controlled company” within the DOJ investigationmeaning of the marketplace rules (the “Listing Rules”) of the Nasdaq Stock Market (“Nasdaq”) and the various claims audits, we were notPatient Square may be able to timely filedetermine all matters requiring stockholder approval.
Reverse Stock Split
On October 12, 2022, at our Quarterly Report2022 annual meeting of stockholders, our stockholders approved an amendment to our Amended and Restated Certificate of Incorporation to effect a reverse stock split of our common stock, at a ratio in the range of 1-for-5 to 1-for-50, with such ratio to be determined by the Board. On January 11, 2023, we announced that the Board had approved a 1-for-20 reverse stock split (the “Reverse Stock Split”), and on Form10-QforJanuary 17, 2023, the three months ended September 30, 2021 (our “Q310-Q”)orReverse Stock Split was effected. Our common stock began trading on a split-adjusted basis on January 18, 2023. All share and per share information presented in this Annual Report on Formfor has been retrospectively adjusted to reflect the year ended December 31, 2021. On November 16, 2021, we filed a Form12b-25notifying the SEC that we would be unable to timely file ourQ3 10-Q.On November 18, 2021, we were notified by the NasdaqReverse Stock Market LLC (“Nasdaq”) that we were not in compliance with Nasdaq Listing Rule 5250(c)(1) for continued listing as a result of the delay in filing ourQ3 10-Qwith the SEC. In accordance with Nasdaq Listing Rules, we submitted a plan to regain compliance. Nasdaq granted us an exception of up to 180 calendar days from theQ3 10-Qoriginal filing due date, or until May 16, 2022, to regain compliance. On March 2, 2022, we filed a Form12b-25notifying the SEC that we would be unable to timely file this Annual Report on Form10-Kfor the year ended December 31, 2021. On March 4, 2022, we were notified again by Nasdaq that we were not in compliance with Nasdaq Listing Rule 5250(c)(1) for continued listing as a result of the delay in filing this Annual Report on Form10-K.As a result, we submitted to Nasdaq an update to our original plan to regain compliance. Nasdaq’s notification dated March 4, 2022 indicated that any additional exception to allow us to regain compliance with all untimely filings will be limited to a maximum of 180 calendar days from the due date of our Q310-Q,or May 16, 2022.
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Factors affecting our business
Our business priorities include: (i) accessing insurance coverage for Eargo hearing aids, including potentially regaining insurance coverage of Eargo hearing aids for government employees under the FEHB program; (ii) refining and expanding our retail strategy; (iii) optimizing our cash-pay business; and (iv) continuing to invest in innovation. We believe that our future performance will depend on many factors, including those described below and in the section titled “Risk Factors” included elsewhere in this Annual Report on Form
Our direct-to-consumer and omni-channel business model
We sell our hearing aids primarily on a direct-to-consumer basis, engaging consumers through a mix of new customers
Via our direct-to-consumer model, customers are able to complete purchases over the phone with an Eargo sales consultant or directly on our website. The Eargo purchasing experience is designed to be simple and to improve the accessibility of hearing aids.
Following the United States Food and Drug Administration (“FDA”) final rule regarding the creation of a strong brand, achieve broad awarenessnew category of our Eargo system, acquire new customers and convert sales leads. Since our public disclosure of the DOJ investigation on September 22, 2021 and our related decision to stop accepting insurance benefits as a method of direct payment,over-the-counter (“OTC”) hearing aids (the “OTC Final Rule”), we have experiencedfocused efforts on transitioning to the new OTC framework and may continue to experience a material decline in gross systems shipped.
Moreover, following the effective date of the OTC Final Rule, we have partnered with certain resellers and other distributors, including retail,benefits managers, to offer Eargo hearing aids for sale through their online storefronts or portals. Under these partnerships, we sell Eargo hearing aids to resellers at wholesale prices, who in turn offer our products to end-customers through their respective online storefronts or portals. Generally, we fulfill and ship orders placed through these online storefronts or portals directly to end-customers, and we generally do not submit insurance claims on behalf of customers who purchase from one of these authorized resellers, including Victra. We believe these partnerships will help expand consumer access to our hearing aids and allow us to target high-intent customers more efficiently. We continue to look for additional partners to help expand our customer base.
Once a customer purchases Eargo hearing aids, whether directly through us or through one of our partners, distributors, or authorized resellers, they are assigned to one of our hearing professionals, who provides complimentary, convenient support by phone, chat or e-mail. Our hearing professionals and customer care team are also available to provide unlimited support for as long as the customer owns an Eargo device. Additionally, we provide short, online training videos and other opportunities,resources that customers can access online. The combination of these services allows us to deliver remote customer support in an efficient and streamlined manner.
We believe our business model and consumer-centric focus offer certain advantages relative to traditional sales channels (which are characterized by a business-to-business model in which hearing aid manufacturers rely on a fragmented network of independent audiology clinics to sell their devices to consumers), including in particular the convenience and accessibility of our remote customer support as well as our consumer-centric focus. We offer free online education, convenient consultation and remote customer support, the potential implementation of cost-savings measures, in orderability to drive cost-efficientcash-paycustomer acquisitioneasily purchase the Eargo system, and offset the significantly higher return rates as well as the related negative impact on revenue and gross margin historically applicable tocash-paycustomers.
Changes to the regulatory landscape
Hearing aids are considered medical devices subject to regulation by the FDA. We currently market our products pursuant toOn August 17, 2022, the FDA published the OTC Final Rule, which established new regulatory frameworkcategories forair-conductionaids, which are classified as Class I or Class II devices exempt from premarket review procedures. In addition, while applicable FDA regulations establish certain “conditions for sale”aids. The OTC Final Rule implements relevant provisions of all hearing aids, including that prospective hearing aid users must have a medical evaluation by a licensed physician within the six months prior to hearing aid dispensation or sign a waiver of medical evaluation, the FDA has stated that it does not intend to enforce these medical evaluation and waiver requirements prior to the dispensing of Class Iair-conductionand Class II wirelessair-conductionhearing aids to individuals 18 years of age and older. Accordingly, while we are required to comply with other FDA requirements, including specific hearing aid labeling requirements and provision of a User Instructional Brochure, our products have not been reviewed by the FDA and are not dispensed by licensed physicians.
We have marketed in the past, and continue to be cleared by the effective date of the Final Rule to continue marketing. For all other currently marketed devices, the proposed compliance date is 180 days after the effective date of the Final Rule (240 days after the publication of the Final Rule).
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for our Eargo 5 and Eargo 6 hearing aids may be marketed under the current“self-fitting” regulation at 21 CFR 874.3323. In December 2022, we received FDA framework during510(k) clearance for Eargo 5 and Eargo 6 as Class II self-fitting air-conduction hearing aids. Additionally, in January 2023, we launched the FDA’s rulemaking proceeding. However, we cannot knowEargo 7 as our third over-the-counter, 510(k) cleared self-fitting device. We plan to what extentmarket our devices as OTC hearing aids and intend to comply with all applicable OTC regulatory requirements as of the compliance date for currently marketed devices on April 14, 2023, or sooner. We may also seek to market certain devices as prescription hearing aids, which would require compliance with separate physical and electronic labeling requirements under the OTC Final Rule may differ fromRule.
In connection with the Proposed Rule. Once the FDA issues aOTC Final Rule, we have expended, and will needcontinue to expend, significant time and resources evaluating the OTC Final Rule and ensuring that our devices and processes come into compliancecomply with the new requirements in order to market our products in line with our primarymodels in the future.models. It is possible that a finalized regulatory framework forthe OTC hearing aidsFinal Rule may lead to additional commercial partnership, omni-channel, including retail, or other opportunities, although there are no assurances that it will do so. The OTC Final Rule and the responses thereto by leading insurance providers could also materially impact our efforts to resume submitting claims for customers with potential insurance benefits or have other unforeseen impacts on our business and results of operations.
Please see the Risk FactorFactors titled, “Changes in the regulatory landscape for hearing aid devices could rendermaterially impact ourcontraryand lead to applicableincreased regulatory requirements, and we may be required to seek additional clearance or approval for our products” and “Our hearing aids are subject to extensive government regulation at the federal and state level, and our failure to comply with applicable requirements could harm our business” for more information.
Insurance-related business
A significant portion of our revenue has historically been dependent on payments from third-party payors; for example, in the year ended December 31, 2021, 44% of total gross systems shipped were to customers with potential insurance coverage. Historically, we submitted claims on behalf of our customers to a concentrated number of third-party payors under certain benefit plans, and substantially all such claims related to the FEHB program.
Between December 31,8, 2021 and 2020, respectively, were for customers with potentialSeptember 15, 2022, we did not accept insurance benefits substantially allas a direct method of whom were covered under the FEHB program. Furthermore, approximately 90% and 45% of our gross accounts receivable as of December 31, 2021 and 2020, respectively, were related to shipments of Eargo hearing aids to customers insured under a single insurance plan whose claims are processed through our largest third-party payor, which conducted the Primary Audit. The increase in gross accounts receivable as of December 31, 2021 was primarily duepayment to the Primary Audit, during which certain claims withCompany, a service date after March 1, 2021 have not yet and may never be submitted by us for reimbursement. We remain subjectpractice we refer to a prepayment review of claims by the payor who conducted the Primary Audit. Additionally,as “direct plan access.” In “direct plan access,” we are subject to a number of other ongoing audits ofsubmit an insurance reimbursement claims. One of these claims audits does not relate to claims submitted under the FEHB program. During the claims audits, the third-party payors (including our largest third-party payor) conducting such claims audits have generally suspended payments for, and in some cases denied, claims we submittedclaim on behalf of customers, other than onean Eargo customer to their insurance plan, or support an Eargo customer in their own claim submission, and the customer’s insurance benefits are utilized for the purchase, in whole or in part. Common forms of utilization can include, but are not limited to, co-pay, payment by a third-party payor to either Eargo or the customer, reimbursement by a third-party payor to the customer, or application toward a customer’s deductible.
Because we do not currently have contracts with any FEHB carriers, third-party payors, or other insurance providers, our products are considered out-of-network with such payors and insurance providers. We do not believe that has continued tothe reimbursement amounts, patient co-payment amounts, or the claims submission process, claims for payment throughout its ongoing audit.
Beginning on September 15, 2022, we intendresumed our direct plan access insurance-based business, accepting insurance benefits as a method of direct payment in certain limited circumstances, when the customer has undergone additional testing by an independent, licensed healthcare provider to workestablish medical necessity, with supporting clinical documentation. We are evaluating additional alternatives for testing or establishing medical necessity, including, but not limited to, contracting with third parties or existing networks of licensed healthcare providers, and/or establishing a management services organization, separate from our existing corporate structure, that manages professional entities that employ licensed healthcare providers. These alternatives involve significant time and related activities, including, but not limited to, development of additional internal processes, training, and compliance and quality control programs, coordination with external healthcare providers and professional services organizations, and evaluation of and compliance with state-by-state regulatory requirements. We cannot provide any assurance as to the governmentefficacy of the processes that we have established or the extent to which such processes will need to be changed, or additional processes established, or the associated timing or costs, whether we will be successful in implementing any of them, or the impact that such processes and third-party payorschanges may have on our business and operations. If we are unable to successfully implement at the appropriate time with the objectiveleast one of validating and establishingthese alternatives for testing, or to otherwise establish additional acceptable processes to support any future claims that we may submit for reimbursement, we expect that we may not be able to arrive at acceptablesubmit future claims in sufficient volume to meaningfully restore or expand the amount of our insurance-based business related to direct plan access. In addition, it is possible that such testing would be required to be conducted in-person, representing a significant change from our past processes or submit any future claims. For example, we do not currently conductin-personhearing tests, as they run counterand customer experience that may adversely impact the attractiveness of our offerings to our primarydirect-to-consumerbusinesscustomers, and omni-channel models. If such processes were to requirein-personhearing tests, we may not be able to efficiently or effectively integrate such tests into our operating model. Further, the OTC Final
61
Rule may lead payors to take additional actions, such as excluding OTC hearing aids from coverage, further limiting our ability to access insurance coverage, or there may be a delay in accessing insurance coverage as payors seek to address the OTC Final Rule in their offered benefits, if at all, any of which may have a material adverse effect on our financial condition, results of operations or cash flows.
We are also seeking to establish relationships with benefits managers or managed care providers. Employer self-funded plans or other health plans may at times offer supplemental benefits, which may include hearing aid benefits or general “over-the-counter” benefits; they may in those cases contract with benefits managers or managed care providers in the administration of such supplemental benefits. In this role, among other things, benefits managers are responsible for selecting benefits vendors, i.e., vendors whose products or services are eligible to be covered by the supplemental benefit. The vendors themselves, or Eargo in this role, are not responsible for claims submissions but instead fulfill the product order from the customer through the benefits manager.
We cannot provide any assurances that we will be able to maintain or increase our participation in arrangements with third-party payors, insurance carriers, benefits managers, or managed care providers or that we will be adequately reimbursed or otherwise paid by such parties for the products we sell, which may have a material adverse effect on our financial condition, results of operations or cash flows.
In light of the DOJ investigations,investigation, claims audits and pendingthe OTC hearing aids regulatory framework,Final Rule, we have made and may continue to need to make significant changes to our business and operating model, including a potential long-term shift to a model that excludes insurance aswithout a direct method of payment,meaningful insurance-related business, which would likely result in a sustained increased cost of customer acquisition and require identification of commercial partnership, omni-channel, including retail, or other opportunities, to drive cost efficient acquisition ofcash-pay
See “—DOJ investigation and settlement and claims audits” for more information. Please see the Risk Factors titled, “We are subject to risks from legal proceedings, investigations, and inquiries, including a number of recent legal proceedings and investigations, which have had and could continue to have a material adverse effect on our reputation, business, financial condition, cash flows and results of operations, and could result in additional claims and material liabilities,” and “We face considerable uncertainty in our business prospects, as a significant portion of our revenue has historically been dependent upon reimbursement from third-party payors participating in the FEHB program, but we have operated on a “cash pay” onlyprimarily “cash-pay” basis since December 8, 2021. Following the civil settlement with the U.S. government on April 29, 2022, weWe may be unsuccessful in validating and establishing processes to support the submission of claims for reimbursement from third-party payors participating in the FEHB program in
Efficient acquisition of new customers
We have spent significant amounts on sales and marketing designed to build a strong brand, achieve broad awareness of our Eargo system, acquire new customers and convert sales leads. Since our public disclosure of the DOJ investigation on September 22, 2021 and our related decision to temporarily stop accepting insurance benefits as a method of direct payment between December 8, 2021 and September 15, 2022, we have experienced and may continue to experience a material decline in sales and gross systems shipped.
From December 8, 2021 until September 15, 2022, as a result of the DOJ investigation and claims audits (as further described in “—DOJ investigation and settlement and claims audits”), we did not accept insurance as a direct method of payment to the Company (referred to as “direct plan access”). Instead, all sales within such timeframe were to customers we refer to as “cash-pay” or “self-pay” customers, which includes upfront payment, credit card, third-party financing, and third-party distributor, authorized reseller or partner payments. We have refocused our sales and marketing efforts and related spend to prioritize conversion of cash-pay consumer leads into satisfied customers. While we intend to continue to work with third-party payors with the objective of validating and establishing additional processes to support any future claims that we may submit for reimbursement, we may not be able to arrive at additional acceptable processes or submit future claims in sufficient volume to meaningfully restore or expand our insurance-based business. The shift to a primarily “cash-pay” model, with minimal volume from our customers using insurance benefits as a direct method of payment to Eargo, will likely result in a sustained increased cost of customer acquisition and require significant sales and marketing investments, based on the historically lower conversion rate for cash-pay customers as compared to direct plan access insurance customers. We anticipate that our expansion into retail locations may allow for a more streamlined sales process; however, it may not ultimately reduce our cost of customer acquisition due to new sales and marketing initiatives related to such expansion. We are currently unable to predict whether our expansion into retail locations will affect the return rate for our cash-pay customers, and the impact any such change may have on our cost of customer acquisition. Further, the low volume of direct plan access insurance customers using insurance as a direct payment method may also necessitate identifying commercial partnerships, omni-channel, including retail, or other opportunities, as well as the potential implementation of cost-savings measures, in order to drive cost-efficient cash-pay customer acquisition and offset the significantly higher return rates as well as the related negative impact on revenue and gross margin historically applicable to cash-pay customers.
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Sales returns rate
Our return policy generally allows our customers to return hearing aids for any reason within the first 45 days of delivery for a full refund, subject to a handling fee in certain states, and can be extended under certain circumstances, including, for example, the previously extended right of return offered for shipments made prior to 2022 involving insurance payors. Historically, the most commonly cited reason for returning our hearing aids is unsatisfactory fit, which we believe is a byproductby-product of our
We report revenue net of expected returns, which is an estimate informed in part by historical return rates. As such, our returns rate impacts our reported net revenue and gross profit.profit or loss. Sales returns rates, as defined under “—Key business metrics,” increased from 26%were 34% and 32% for the yearyears ended December 31, 2020 to 32% for the year ended December 31,2022 and 2021, primarily due to our sales returns rate of 46% in the third quarter of 2021, which was driven by our estimate that a majority of customers with unsubmitted claims related to products shipped during the third quarter of 2021 will choose to return the hearing aid system if their insurer denies their claim or the claim is ultimately not submitted by us for payment.
New product introductions
Our technical capabilities and commitment to innovation have allowed us to deliver product enhancements on a rapid development timeline and support a compelling new product roadmap that we believe will continue to differentiate our competitive position over the next several years. With the full commercial launch of the Eargo 57 in July 2021 and the launch of Eargo 6 in January 2022,February 2023, we have now launched sixseven generations of our hearing aids since 2017, with each iteration having increased functionality and improved sound quality, amplification, noise reduction, physical fit, comfort, water resistance and
We expect to continue refining and improving Eargo hearing aids, and we have the intention of an approximate annual cadence of new product launches. To this end, we are working on the development of a cost-conscious offering as well as the next Eargo hearing aid model with improved functionality. Accordingly, we expect to continue to invest in research and development to support new product introductions. In connection with our product innovation and iteration, we also need to successfully manage our product transitions to avoid delays in customer purchases, excess or obsolete inventory and increased returns as customers wait for our new products to become available. Our development priorities are focused, in part, on expanding refurbishment capability for returned hearing aids. Our refurbishment capabilities include full refurbishment, conversion, andare focused on components and allow us to refurbish and resell or reuse certain key components from our returned devices.
Recruitment and retention of personnel
Our success depends in part upon our continued ability to recruit, retain and motivate high-quality employees, including management, administrative, our clinical and scientific personnel and our direct sales force (among others), and competition for qualified personnel can be intense due to the limited number of individuals possessing the requisite training, skill and experience we require. As a result of uncertainty created by the DOJ investigation and the claims audits, we temporarily suspended our practice of granting equity awards, (except for new
In addition, on December 7, 2021, we announced a plan to reduce our employee workforce to streamline our organization in response to declines in customer orders since we announced the DOJ investigation. We substantially completed the employee workforce reduction during the fourth quarter of 2021, resulting in a reduction of approximately 27% of our employee workforce, or approximately 90 people. BothOn May 24, 2022, we announced a plan to further reduce our employee workforce as part of continued cost-cutting measures to reduce operating expenses and preserve capital. We substantially completed the employee workforce reduction during the second quarter of 2022, resulting in a reduction of approximately 17% of our employee workforce, or 44 people.
Future suspension of equity awards, including of our practice of granting RSUs, and reductionreductions in workforce, in addition to any negative perceptions of employment with us as a result of the DOJ investigation, the settlement with the U.S. government, and the claims audits, could continue to adversely affect employee morale and have a material adverse impact on our ability to recruit, retain and motivate the high-quality employees critical to our operations, which in turn could have a material adverse effect on our business, results of operations and financial condition.
Macroeconomic environment
Our business, results of operation and financial condition are dependent on macroeconomic conditions. We face domestic as well as global macroeconomic challenges, particularly in light of the effects of the COVID-19
We believe the 63 in-person has accelerated the pace of consumer awareness of our vertically integrated telecareremote customer support model and has facilitated customer adoption of the same.has resulted in increased knowledge of our business and sales. Wesales and a potential acceleration of consumer acceptance of our primarily direct-to-consumer business model. However, we cannot be sure whether this trend in consumer behavior will continue.
We rely on a number of international suppliers and manufacturers, including our primary manufacturer, Pegatron Corporation, who is headquartered in Taiwan, which exposes us to foreign operational and political risks such as changes in trade policies and export regulations between the United States and other countries or geopolitical conflict. Additionally, although we believe the we have experienced business disruptions, particularly at our California headquarters, where a majority of our employees have been working remotely (which we permitted as an accommodation to our employees despite the fact that we were never required to close our facilities because we were deemed to have an essential workforce under the relevant CaliforniaCOVID-19measures). Moreover, travel restrictions, factory closures and disruptions in global supply chains have resulted in industry-wide component supply shortages (such as in semiconductors), and we may not be able to obtain adequate inventory on a timely basis or at all. To date, increases in component pricing have occurred but have not had a material impact on supply continuity.continuity or gross margin. We have taken steps to monitor our supply chain and actions to address limited supply and increasing lead times, including outreach to critical suppliers and spot market purchases. While we have not been impacted byexperienced any significant disruptions to our supply chain that have impacted our ability to service customers or our access to necessary raw materials and component parts for the manufacture of our products to date, disruptions have occurred across a number of industries and we cannot provide any assurance that future disruptions will not emerge as a result of the ongoing supply chain issues, inflation, thesalesrevenue and gross margins.
For a further discussion of trends, uncertainties and other factors that could impact our operating results, see the section titled “Risk Factors” in Item 1A of Part I in this Annual Report on Form 10-K.
Key business metrics
To analyze our business performance, determine financial forecasts and help develop long-term strategic plans, we review the following key business metrics, each of which is an important measure that represents the state of our business:
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The following table details the number of gross systems shipped and sales returns rates for the periods presented below:
Three months ended | ||||||||||||||||||||||||||||||||
March 31, 2020 | June 30, 2020 | September 30, 2020 | December 31, 2020 | March 31, 2021 | June 30, 2021 | September 30, 2021 | December 31, 2021 | |||||||||||||||||||||||||
Gross systems shipped | 7,030 | 9,040 | 10,077 | 12,096 | 11,704 | 12,548 | 13,117 | 7,767 | ||||||||||||||||||||||||
Sales returns rate | 28.2 | % | 27.1 | % | 25.2 | % | 24.3 | % | 23.2 | % | 24.1 | % | 46.4 | % | 34.0 | % |
|
| Three months ended |
| |||||||||||||||||||||||||||||
|
| Mar 31, |
|
| Jun 30, |
|
| Sep 30, |
|
| Dec 31, |
|
| Mar 31, |
|
| Jun 30, |
|
| Sep 30, |
|
| Dec 31, |
| ||||||||
Gross systems shipped |
|
| 11,704 |
|
|
| 12,548 |
|
|
| 13,117 |
|
|
| 7,767 |
|
|
| 5,773 |
|
|
| 4,455 |
|
|
| 5,156 |
|
|
| 8,863 |
|
Sales returns rate |
|
| 23.2 | % |
|
| 24.1 | % |
|
| 46.4 | % |
|
| 34.0 | % |
|
| 33.9 | % |
|
| 33.3 | % |
|
| 32.3 | % |
|
| 34.9 | % |
During the three and twelve months ended December 31, 2022 and 2021, the CompanyEargo shipped 7,76724,247 and 45,136 gross hearing aid systems, respectively, approximately 20%of which less than 1% and 44% of which,, respectively, were to customers with potential insurance coverage.
We believe these key business metrics provide useful information to help investors understand and evaluate our business performance. Gross systems shipped is a key measure of sales volume, which drives potential revenue, while sales returns rates are an indicator of expected reductions to revenue and an indicator of change in customer mix and factors affecting the returns rates by customer type. However, as discussed elsewhere in this report, our sales volume, sales returns rate and revenue during the current yearperiod were not consistent with the prior yearperiods as a result of the DOJ investigation and settlement and claims audits. See “—DOJ investigation and settlement and claims audits.”
Due to the historically higher return rate forwe are unable to acceptthere is minimal volume from our customers using insurance benefits as a direct method of payment.
Components of our results of operations
See the discussion under “—DOJ investigation and settlement and claims audits,” which describes a variety of circumstances currently affecting our business and results of operations, and which require that we continually evaluate and adapt our business model and expenditures as new information becomes available.
Revenue, net
We generate revenue primarily from the sale of Eargo hearing aid systems, accessories and, tosystems. We market a lesser extent, salesvariety of extended warranties, with the majoritymodels of our revenue coming from sales of our Eargo hearing aid systems.
Since learning of the DOJ investigation, we havetemporarily suspended all insurance claims submissions and, beginning onfrom December 8, 2021 dountil September 15, 2022, did not currently accept insurance as a direct method of payment. Instead, we are currently focused our efforts on“cash-pay”financingfinanced payments and distributor payment.payments. Historically,currentpotential long-term shift toonly sales may adversely impact revenue, net.
Cost of revenue and gross margin
Cost of revenue consists of expenses associated with the cost of finished goods, freight, personnel costs, consumables, product warranty costs, transaction fees, reserves for excess and obsolete inventory, depreciation and amortization, and related overhead.
Our gross margin has been and will continue to be affected by a variety of factors, including sales volumes, product mix, channel mix, pricing strategies, sales returns rates, costs of finished goods, product warranty claim rates and refurbishment strategies, and our ability to service insurance customers in the future and any potential actions insurance providers may take following the anticipated implementation of a pendingthe FDA’s new OTC hearing aid regulatory framework that may limit our ability to access insurance coverage (which OTC framework may also generally result in additional compliance or other regulatory requirements for Eargo).
We expect our gross margin to remain depressed for so long as we are unable to acceptthere is minimal volume from our customers using insurance benefits as a direct method of payment to Eargo, unless we can successfully target and convert new customers with a similarly low rate of return.
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Research and development expenses
Research and development (“R&D”) expenses, consist primarily of engineering and product development costs to develop and support our products, regulatory expenses,
Sales and marketing expenses
Our sales and marketing expenses arehave generally been the largest component of our operating expenses and consist primarily of personnel-related costs, including salaries and stock-based compensation, direct and channel marketing, advertising and promotional expenses, consulting fees, public relations costs and allocated facility overhead costs. Sales and marketing personnel include our direct sales force consisting of inside sales consultants, hearing professionals, marketing professionals and related support personnel. We expect our sales and marketing expenses to fluctuate over time as a percentage of revenue. In response to the factors discussed in “—DOJ investigation and settlement and claims audits,” we have reduced sales and marketing resources that were previously focused on insurance customers to prioritize the conversion ofas part of the reduction2021 and 2022 reductions in force announced on December 8, 2021.
General and administrative expenses
Our general and administrative expenses consist primarily of compensation for executive, finance, legal, information technology and administrative personnel, including stock-based compensation. Other significant expenses include professional fees for legal and accounting services, transaction fees, consulting fees, recruiting fees, information technology costs, corporate insurance, bad debt expense, general corporate expenses and allocated facility overhead costs.
Excluding the costs associated with the DOJ investigation, we expect our general and administrative expenses will increase in absolute dollars in future periods as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the SEC, and those of the Nasdaq Stock Market, additional insurance costs, investor relations activities and other administrative and professional services, as well as professional service and legal fees and expenses related to shareholder litigation that has been filed and that may be filed in the future.
Interest income
Interest income consists of interest earned on cash and cash equivalents.
Interest expense
Interest expense consists of interest related to borrowings under our debt obligations and our convertible promissory notes prior to their redemption in July 2020.
Change in fair value of our convertible preferred stock warrant liabilities priornotes
We elected on issuance to account for the Notes at fair value until their reclassificationsettlement. The change in fair value of the convertible notes is recognized in the consolidated statements of operations, with the exception of changes in fair value due to additionalpaid-incapital upon the closinginstrument-specific credit risk, which are recorded as a component of our IPO in October 2020.
Loss on extinguishment of debt
The loss on extinguishment of debt arose onfrom the redemptionearly repayment of long-term debt under our convertible promissory notes (“2020 Notes”) into shares of our Series E convertible preferred stock2018 Loan Agreement in July 2020.
Income tax provision
We use the asset and liability method to account for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts of existing assets and liabilities and their tax bases. Deferred tax assets and liabilities are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. Due to our historical operating performance and our recorded cumulative net losses in prior fiscal periods, our net deferred tax assets have been fully offset by a valuation allowance.
Financial statement effects of uncertain tax positions are recognized when it is
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Results of operations
Comparison of the years ended December 31, 2022 and 2021
We made the decision to temporarily stop accepting insurance benefits as a method of direct payment between December 8, 2021 and 2020
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2021 | 2020 | Amount | % | ||||||||||||
Revenue, net | $ | 32,122 | $ | 69,154 | $ | (37,032 | ) | (53.6 | )% | |||||||
Cost of revenue | 27,956 | 21,873 | 6,083 | 27.8 | ||||||||||||
Gross profit | 4,166 | 47,281 | (43,115 | ) | (91.2 | ) | ||||||||||
Operating expenses: | ||||||||||||||||
Research and development | 25,232 | 12,045 | 13,187 | 109.5 | ||||||||||||
Sales and marketing | 85,759 | 49,525 | 36,234 | 73.2 | ||||||||||||
General and administrative | 49,882 | 20,582 | 29,300 | 142.4 | ||||||||||||
Total operating expenses | 160,873 | 82,152 | 78,721 | 95.8 | ||||||||||||
Loss from operations | (156,707 | ) | (34,871 | ) | (121,836 | ) | 349.4 | |||||||||
Other income (expense), net: | ||||||||||||||||
Interest income | 21 | 37 | (16 | ) | (43.2 | ) | ||||||||||
Interest expense | (1,068 | ) | (1,920 | ) | 852 | (44.4 | ) | |||||||||
Other income (expense), net | — | (1,474 | ) | 1,474 | (100.0 | ) | ||||||||||
Loss on extinguishment of debt | — | (1,627 | ) | 1,627 | (100.0 | ) | ||||||||||
Total other income (expense), net | (1,047 | ) | (4,984 | ) | 3,937 | (79.0 | ) | |||||||||
Loss before income taxes | (157,754 | ) | (39,855 | ) | (117,899 | ) | 295.8 | |||||||||
Income tax provision | — | — | — | — | ||||||||||||
Net loss and comprehensive loss | $ | (157,754 | ) | $ | (39,855 | ) | $ | (117,899 | ) | 295.8 | % | |||||
Revenue, which is reported net of consideration payable to customers and expected returns, increased by $5.1 million, or 16.0%, from $32.1 million during the year ended December 31, 2021 to $37.2 million during the year ended December 31, 2022.
In September 2022, we made the determination not to seek payment for approximately $16.1 million from customers with unsubmitted and unpaid claims, or the Pricing Concession. This decision resulted in a reduction in net revenue of $0.3 million for the year ended December 31, 2022 after the remeasurement of the corresponding sales return reserve and the utilization of the related allowance for expected credit losses.
During the year ended December 31, 2021, the $34.4 million settlement amount associated with the DOJ investigation was recorded as a reduction in revenue. Additionally, we previously estimated that a majority of customers with unsubmitted claims as of December 31, 2021 would choose to return the hearing aid system if their insurance provider denied their claim or the claim was ultimately not submitted by us for payment, resulting in an increase in expected product returns from such transactions that occurred prior to September 21, 2021. As a result, we recorded $13.3 million of estimated sales returns as a reduction in revenue in the third quarter of 2021 related to shipments to customers with potential insurance benefits. Further, we did not recognize revenue and related sales
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returns reserve on approximately 2,230 Eargo hearing aid systems shipped during the year ended December 31, 2021 and subsequent to learning of the DOJ investigation, as these transactions did not meet the criteria for revenue recognition.
Cost of revenue, gross profit, and gross margin
|
| Year ended |
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| Change |
| ||||||||||
(dollars in thousands) |
| 2022 |
|
| 2021 |
|
| Amount |
|
| % |
| ||||
Cost of revenue |
| $ | 22,988 |
|
| $ | 27,956 |
|
| $ | (4,968 | ) |
|
| (17.8 | )% |
Gross profit |
|
| 14,260 |
|
|
| 4,166 |
|
|
| 10,094 |
|
|
| 242.3 | % |
Gross margin |
|
| 38.3 | % |
|
| 13.0 | % |
|
|
|
|
|
|
Cost of revenue decreased by $5.0 million, or 17.8%, from $28.0 million during 2021 to $23.0 million during 2022. The change was primarily due to the decrease in the volume of Eargo hearing aid systems shipped, partially offset by charges related to certain slow moving inventory items.
Gross margin increased to 38.3% during 2022, compared to 13.0% during 2021. The increase in gross margins is primarily due to revenue-related adjustments made in 2021, including the $34.4 million settlement amount associated with the DOJ investigation, the expected increase in product returns from customers with unsubmitted claims, as well as the approximately 2,230 Eargo hearing aid systems shipped during the year ended December 31, 2021, for which no revenue was recognized as the transactions did not meet criteria for revenue recognition.
Estimated sales returns are recorded as a reduction in revenue. The $18.2 million of estimated sales returns recorded during 2022 significantly decreased from the $37.7 million of estimated sales returns recorded during 2021. The reduction is attributable primarily to $13.3 million recorded during the year ended December 31, 2021 for estimated sales returns related to the expected increase in product returns from shipments to customers with potential insurance benefits and the reduction in the number of our gross systems shipped during the year ended December 31, 2022.
Research and development (R&D)
|
| Year ended |
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| Change |
| ||||||||||
(dollars in thousands) |
| 2022 |
|
| 2021 |
|
| Amount |
|
| % |
| ||||
Research and development |
| $ | 18,813 |
|
| $ | 25,232 |
|
| $ | (6,419 | ) |
|
| (25.4 | )% |
R&D expenses decreased by $6.4 million, or 25.4%, from $25.2 million during 2021 to $18.8 million during 2022. The change was primarily due to the impact of decreased headcount, a net decrease of $5.5 million in personnel and personnel-related costs due in part to a decrease in stock-based compensation, primarily related to the suspension of our ESPP in November 2021 and a reduction in cumulative compensation costs of $1.8 million recognized during the year ended December 31, 2022 related to the non-achievement of certain performance targets for restricted stock units. Additionally, during the year ended December 31, 2022, there was a net decrease of $1.1 million in third-party costs subsequent to the commercial launches of Eargo 5 in July 2021 and Eargo 6 in January 2022.
Sales and marketing
|
| Year ended |
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(dollars in thousands) |
| 2022 |
|
| 2021 |
|
| Amount |
|
| % |
| ||||
Sales and marketing |
| $ | 52,947 |
|
| $ | 85,759 |
|
| $ | (32,812 | ) |
|
| (38.3 | )% |
Sales and marketing expenses decreased by $32.8 million, or 38.3%, from $85.8 million during 2021 to $52.9 million during 2022. The change was primarily due to decreases in direct marketing, advertising and promotional expenses of $19.5 million due to a reduction in media spend following our decision to temporarily stop accepting insurance benefits as a method of direct payment on December 8, 2021, and decreases in personnel and personnel-related costs of $13.3 million due to decreased headcount and suspension of our ESPP in November 2021.
General and administrative
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| Year ended |
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(dollars in thousands) |
| 2022 |
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| 2021 |
|
| Amount |
|
| % |
| ||||
General and administrative |
| $ | 54,259 |
|
| $ | 49,882 |
|
| $ | 4,377 |
|
|
| 8.8 | % |
General and administrative expenses increased by $4.4 million, or 8.8%, from $49.9 million during 2021 to $54.3 million during 2022. This change was primarily due to an increase of $6.6 million in general corporate costs primarily related to legal, accounting, consulting and other professional fees driven by activities related to the DOJ investigation and compliance matters and increase in
68
insurance overhead costs as a result of operating as a public company, and $5.7 million in third-party costs related to the issuance of the Notes. The increase was partially offset by a net decrease in bad debt expense during the year ended December 31, 2022. During the year ended December 31, 2021 our bad debt expense was higher by $8.9 million, based on our estimate that a significant number of customers whose claims are denied by insurance providers or not submitted by us for payment may not pay for or return the hearing aid system.
Interest income
|
| Year ended |
|
| Change | |||||||||
(dollars in thousands) |
| 2022 |
|
| 2021 |
|
| Amount |
|
| % | |||
Interest income |
| $ | 1,196 |
|
| $ | 21 |
|
| $ | 1,175 |
|
| * |
Interest income increased by $1.2 million, from $0.1 million during 2021 to $1.2 million during 2022. The increase in interest income was primarily attributable to the increased interest rates on cash balances during 2022.
Interest expense
|
| Year ended |
|
| Change |
| ||||||||||
(dollars in thousands) |
| 2022 |
|
| 2021 |
|
| Amount |
|
| % |
| ||||
Interest expense |
| $ | (549 | ) |
| $ | (1,068 | ) |
| $ | 519 |
|
|
| (48.6 | )% |
Interest expense decreased by $0.5 million, or 48.6%, from $1.1 million during 2021 to $0.6 million during 2022. The decrease in interest expense was primarily attributable to the repayment of long-term debt under our 2018 Loan Agreement in June 2022 and our accounting policy election to account for the Notes at fair value and include interest expense related to the Notes in the changes in fair value.
Change in fair value of convertible notes
|
| Year ended |
|
| Change | |||||||||
(dollars in thousands) |
| 2022 |
|
| 2021 |
|
| Amount |
|
| % | |||
Change in fair value of convertible notes |
| $ | (45,503 | ) |
| $ | — |
|
| $ | (45,503 | ) |
| * |
The change in fair value of convertible notes payable of $45.5 million for the year ended December 31, 2022 represents the difference between the fair value of the Notes at issuance and the fair value of the Conversion Shares on the dates of settlement. Prior to the closing of the Rights Offering, the fair value of the Notes was estimated as a combination of our equity, an option on our equity valued using the Black-Scholes option pricing model, and a short position in a bond valued under the discounted cash flow model. The conversion date fair value of the Notes was estimated based on the closing price of the Company’s common stock adjusted for the impact of certain legal restrictions on the Conversion Shares.
Loss on extinguishment of debt
|
| Year ended |
|
| Change | |||||||||
(dollars in thousands) |
| 2022 |
|
| 2021 |
|
| Amount |
|
| % | |||
Loss on extinguishment of debt |
| $ | (772 | ) |
| $ | — |
|
| $ | (772 | ) |
| * |
Loss on extinguishment of debt of $0.8 million for the year ended December 31, 2022 arose from the early repayment of long-term debt under our 2018 Loan Agreement in June 2022.
69
Comparison of the years ended December 31, 2021 and 2020
|
| Year ended |
|
| Change |
| ||||||||||
(dollars in thousands) |
| 2021 |
|
| 2020 |
|
| Amount |
|
| % |
| ||||
Revenue, net |
| $ | 32,122 |
|
| $ | 69,154 |
|
| $ | (37,032 | ) |
|
| (53.6 | )% |
Cost of revenue |
|
| 27,956 |
|
|
| 21,873 |
|
|
| 6,083 |
|
|
| 27.8 |
|
Gross profit |
|
| 4,166 |
|
|
| 47,281 |
|
|
| (43,115 | ) |
|
| (91.2 | ) |
Operating expenses: |
|
|
|
|
|
|
|
|
|
|
|
| ||||
Research and development |
|
| 25,232 |
|
|
| 12,045 |
|
|
| 13,187 |
|
|
| 109.5 |
|
Sales and marketing |
|
| 85,759 |
|
|
| 49,525 |
|
|
| 36,234 |
|
|
| 73.2 |
|
General and administrative |
|
| 49,882 |
|
|
| 20,582 |
|
|
| 29,300 |
|
|
| 142.4 |
|
Total operating expenses |
|
| 160,873 |
|
|
| 82,152 |
|
|
| 78,721 |
|
|
| 95.8 |
|
Loss from operations |
|
| (156,707 | ) |
|
| (34,871 | ) |
|
| (121,836 | ) |
|
| 349.4 |
|
Other income (expense), net: |
|
|
|
|
|
|
|
|
|
|
|
| ||||
Interest income |
|
| 21 |
|
|
| 37 |
|
|
| (16 | ) |
|
| (43.2 | ) |
Interest expense |
|
| (1,068 | ) |
|
| (1,920 | ) |
|
| 852 |
|
|
| (44.4 | ) |
Other income (expense), net |
|
| — |
|
|
| (1,474 | ) |
|
| 1,474 |
|
| * |
| |
Loss on extinguishment of debt |
|
| — |
|
|
| (1,627 | ) |
|
| 1,627 |
|
| * |
| |
Total other income (expense), net |
|
| (1,047 | ) |
|
| (4,984 | ) |
|
| 3,937 |
|
|
| (79.0 | ) |
Loss before income taxes |
|
| (157,754 | ) |
|
| (39,855 | ) |
|
| (117,899 | ) |
|
| 295.8 |
|
Income tax provision |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
Net loss and comprehensive loss |
| $ | (157,754 | ) |
| $ | (39,855 | ) |
| $ | (117,899 | ) |
|
| 295.8 | % |
* Not Meaningful
Revenue, net
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2021 | 2020 | Amount | % | ||||||||||||
Revenue, net | $ | 32,122 | $ | 69,154 | $ | (37,032 | ) | (53.6 | )% | |||||||
|
| Year ended |
|
| Change |
| ||||||||||
(dollars in thousands) |
| 2021 |
|
| 2020 |
|
| Amount |
|
| % |
| ||||
Revenue, net |
| $ | 32,122 |
|
| $ | 69,154 |
|
| $ | (37,032 | ) |
|
| (53.6 | )% |
Gross systems shipped during 2021 were 45,136, compared to 38,243 in 2020. The increase in shipment volume was largely driven by a continued expansion in national marketing efforts and customer adoption of our telecare model. However, revenue, which is reported net of consideration payable to customers and expected returns, decreased by $37.0 million, or 53.6%, from $69.2 million during the year ended December 31, 2020 to $32.1 million during the year ended December 31, 2021.
The $34.4 million settlement amount associated with the DOJ investigation was recorded as a reduction in revenue during the year ended December 31, 2021. Additionally, we estimated that a majority of customers with unsubmitted claims will choose to return the hearing aid system if their insurance provider denies their claim or the claim is ultimately not submitted by us for payment, resulting in an increase in expected product returns from such transactions that occurred prior to September 21, 2021. As a result, we recorded $13.3 million of estimated sales returns as a reduction in revenue in the third quarter of 2021 related to shipments to customers with potential insurance benefits.
Further, we did not recognize revenue and related sales returns reserve on approximately 2,230 Eargo hearing aid systems shipped during third and fourth quarters of 2021 subsequent to learning of the DOJ investigation, as these transactions did not meet the criteria for revenue recognition under ASC 606.recognition. We recognized revenue on approximately 42,910 Eargo hearing aid systems shipped to customers during 2021, a 12.2% increase compared to the 38,243 Eargo hearing aid systems for which revenue was recognized during 2020. The impact on revenue from an increase in the volume of shipments was offset by the $34.4 million settlement amount, the increase in expected returns from customers with potential insurance benefits and with unsubmitted claims as of December 31, 2021, and by the hearing aid systems shipped for which we did not recognize revenue.
Cost of revenue, gross profit, and gross margin
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2021 | 2020 | Amount | % | ||||||||||||
Cost of revenue | $ | 27,956 | $ | 21,873 | $ | 6,083 | 27.8 | % | ||||||||
Gross profit | 4,166 | 47,281 | (43,115 | ) | (91.2 | )% | ||||||||||
Gross margin | 13.0 | % | 68.4 | % | ||||||||||||
|
| Year ended |
|
| Change |
| ||||||||||
(dollars in thousands) |
| 2021 |
|
| 2020 |
|
| Amount |
|
| % |
| ||||
Cost of revenue |
| $ | 27,956 |
|
| $ | 21,873 |
|
| $ | 6,083 |
|
|
| 27.8 | % |
Gross profit |
|
| 4,166 |
|
|
| 47,281 |
|
|
| (43,115 | ) |
|
| (91.2 | )% |
Gross margin |
|
| 13.0 | % |
|
| 68.4 | % |
|
|
|
|
|
|
70
Cost of revenue increased by $6.1 million, or 27.8%, from $21.9 million during 2020 to $28.0 million during 2021. The change was primarily due to the increase in the volume of Eargo hearing aid systems shipped, product mix shift towards Eargo 5 which has a higher average product cost, and higher depreciation and software amortization related to the Eargo 5 commercial launch in July 2021.
Gross margin decreased to 13.0% during 2021, compared to 68.4% during 2020. The decrease in gross margins is primarily due to the $34.4 million settlement amount associated with the DOJ investigation, the expected increase in product returns from customers with unsubmitted claims, the approximately 2,230 Eargo hearing aid systems shipped during the third and fourth quarters of 2021 for which we did not recognize related revenue, and a product mix shift towards Eargo 5, which has a higher cost of goods per product sold.
Estimated sales returns are recorded as a reduction in revenue. The $37.7 million of estimated sales returns recorded during 2021 is an increase of $15.0 million from the $22.7 million of estimated sales returns recorded
Research and development (R&D)
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2021 | 2020 | Amount | % | ||||||||||||
Research and development | $ | 25,232 | $ | 12,045 | $ | 13,187 | 109.5 | % | ||||||||
|
| Year ended |
|
| Change |
| ||||||||||
(dollars in thousands) |
| 2021 |
|
| 2020 |
|
| Amount |
|
| % |
| ||||
Research and development |
| $ | 25,232 |
|
| $ | 12,045 |
|
| $ | 13,187 |
|
|
| 109.5 | % |
R&D expenses increased by $13.2 million, or 109.5%, from $12.0 million during 2020 to $25.2 million during 2021. The change was primarily due to a net increase of $10.6 million in personnel and personnel-related costs, which includes the impact of increased headcount and an increase in stock-based compensation of $6.1 million, and a net increase of $1.8 million in third-party costs related to current and future product development initiatives.
Sales and marketing
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2021 | 2020 | Amount | % | ||||||||||||
Sales and marketing | $ | 85,759 | $ | 49,525 | $ | 36,234 | 73.2 | % | ||||||||
|
| Year ended |
|
| Change |
| ||||||||||
(dollars in thousands) |
| 2021 |
|
| 2020 |
|
| Amount |
|
| % |
| ||||
Sales and marketing |
| $ | 85,759 |
|
| $ | 49,525 |
|
| $ | 36,234 |
|
|
| 73.2 | % |
Sales and marketing expenses increased by $36.2 million, or 73.2%, from $49.5 million during 2020 to $85.8 million during 2021. The change was primarily due to increases in direct marketing, advertising and promotional expenses of $18.9 million, partially driven by increased rates due to decreased cable TV viewership in our core demographic, and an increase in personnel and personnel-related costs of $17.3 million, which includes the impact of increased headcount (a trend that was reversed in the fourth quarter of 2021 as further described in the introductory paragraph to this “—Results of operations” and “—DOJ investigation and settlement and claims audits”), higher commissions from increased sales and an increase in stock-based compensation of $9.6 million.
General and administrative
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2021 | 2020 | Amount | % | ||||||||||||
General and administrative | $ | 49,882 | $ | 20,582 | $ | 29,300 | 142.4 | % | ||||||||
|
| Year ended |
|
| Change |
| ||||||||||
(dollars in thousands) |
| 2021 |
|
| 2020 |
|
| Amount |
|
| % |
| ||||
General and administrative |
| $ | 49,882 |
|
| $ | 20,582 |
|
| $ | 29,300 |
|
|
| 142.4 | % |
General and administrative expenses increased by $29.3 million, or 142.4%, from $20.6 million during 2020 to $49.9 million during 2021. This change was primarily due to an increase in general corporate costs of $14.3 million, an increase in personnel and personnel-related costs of $9.7 million, and a net increase in bad debt expense of $7.3 million.
The change in general corporate costs includes $8.4 million in legal and other professional fees as a result of the DOJ investigation as well as increased costs as a result of operating as a public company. The change in
Interest expense
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2021 | 2020 | Amount | % | ||||||||||||
Interest expense | $ | (1,068 | ) | $ | (1,920 | ) | $ | 852 | (44.4 | )% | ||||||
|
| Year ended |
|
| Change |
| ||||||||||
(dollars in thousands) |
| 2021 |
|
| 2020 |
|
| Amount |
|
| % |
| ||||
Interest expense |
| $ | (1,068 | ) |
| $ | (1,920 | ) |
| $ | 852 |
|
|
| (44.4 | )% |
71
Interest expense decreased by $0.9 million, or 44.4%, from $1.9 million during 2020 to $1.1 million during 2021. The decrease in interest expense was primarily attributable to lower long-term debt balance outstanding and lower related interest rate during 2021 as compared 2020.
Other income (expense), net
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2021 | 2020 | Amount | % | ||||||||||||
Other income (expense), net | $ | — | $ | (1,474 | ) | $ | 1,474 | (100.0 | )% | |||||||
|
| Year ended |
|
| Change | |||||||||
(dollars in thousands) |
| 2021 |
|
| 2020 |
|
| Amount |
|
| % | |||
Other income (expense), net |
| $ | — |
|
| $ | (1,474 | ) |
| $ | 1,474 |
|
| * |
Other income (expense), net during 2020 consisted primarily of adjustments to the fair value of our convertible preferred stock warrant liabilities prior to their reclassification to additionalperiod.
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2020 | 2019 | Amount | % | ||||||||||||
Revenue, net | $ | 69,154 | $ | 32,790 | $ | 36,364 | 110.9 | % | ||||||||
Cost of revenue | 21,873 | 15,790 | 6,083 | 38.5 | ||||||||||||
Gross profit | 47,281 | 17,000 | 30,281 | 178.1 | ||||||||||||
Operating expenses: | ||||||||||||||||
Research and development | 12,045 | 12,841 | (796 | ) | (6.2 | ) | ||||||||||
Sales and marketing | 49,525 | 35,725 | 13,800 | 38.6 | ||||||||||||
General and administrative | 20,582 | 12,470 | 8,112 | 65.1 | ||||||||||||
Total operating expenses | 82,152 | 61,036 | 21,116 | 34.6 | ||||||||||||
Loss from operations | (34,871 | ) | (44,036 | ) | 9,165 | (20.8 | ) | |||||||||
Other income (expense), net: | ||||||||||||||||
Interest income | 37 | 627 | (590 | ) | (94.1 | ) | ||||||||||
Interest expense | (1,920 | ) | (711 | ) | (1,209 | ) | 170.0 | |||||||||
Other income (expense), net | (1,474 | ) | (366 | ) | (1,108 | ) | 302.7 | |||||||||
Loss on extinguishment of debt | (1,627 | ) | — | (1,627 | ) | * | ||||||||||
Total other income (expense), net | (4,984 | ) | (450 | ) | (4,534 | ) | 1,008 | |||||||||
Loss before income taxes | (39,855 | ) | (44,486 | ) | 4,631 | (10.4 | ) | |||||||||
Income tax provision | — | — | — | — | ||||||||||||
Net loss and comprehensive loss | $ | (39,855 | ) | $ | (44,486 | ) | $ | 4,631 | (10.4 | )% | ||||||
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2020 | 2019 | Amount | % | ||||||||||||
Revenue, net | $ | 69,154 | $ | 32,790 | $ | 36,364 | 110.9 | % | ||||||||
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2020 | 2019 | Amount | % | ||||||||||||
Cost of revenue | $ | 21,873 | $ | 15,790 | $ | 6,083 | 38.5 | % | ||||||||
Gross profit | 47,281 | 17,000 | 30,281 | 178.1 | % | |||||||||||
Gross margin | 68.4 | % | 51.8 | % | ||||||||||||
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2020 | 2019 | Amount | % | ||||||||||||
Research and development | $ | 12,045 | $ | 12,841 | $ | (796 | ) | (6.2 | )% | |||||||
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2020 | 2019 | Amount | % | ||||||||||||
Sales and marketing | $ | 49,525 | $ | 35,725 | $ | 13,800 | 38.6 | % | ||||||||
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2020 | 2019 | Amount | % | ||||||||||||
General and administrative | $ | 20,582 | $ | 12,470 | $ | 8,112 | 65.1 | % | ||||||||
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2020 | 2019 | Amount | % | ||||||||||||
Interest income | $ | 37 | $ | 627 | $ | (590 | ) | (94.1 | )% | |||||||
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2020 | 2019 | Amount | % | ||||||||||||
Interest expense | $ | (1,920 | ) | $ | (711 | ) | $ | (1,209 | ) | 170.0 | % | |||||
Year ended December 31, | Change | |||||||||||||||
(dollars in thousands) | 2020 | 2019 | Amount | % | ||||||||||||
Other income (expense), net | $ | (1,474 | ) | $ | (366 | ) | $ | (1,108 | ) | 302.7 | % | |||||
Liquidity and capital resources
Sources of liquidity and operating capital requirements
Since our inception, we have incurred net losses and negative cash flows from operations. We have funded our operations primarily from the net proceeds received from the sale of our equity securities, indebtedness and revenue from the sale of our products.
Pursuant to the Note Purchase Agreement, the PSC Stockholder agreed to purchase up to an additional $25.0 million of Notes if the Company completed the Rights Offering within 150 days after the First Tranche Closing and the existing stockholders of Eargo subscribed to purchase less than 3,750,000 shares of newly issued common stock in such Rights Offering.
The Rights Offering expired on November 17, 2022 and existing stockholders of Eargo subscribed for an aggregate of 9,029,629approximately 2.9 million shares of common stock. On November 23, 2022, the Rights Offering was consummated, and we received net proceeds of approximately $27.6 million from existing stockholders. In accordance with the terms of the Note Purchase Agreement, on November 25, 2022, the PSC Stockholder purchased an additional approximately $5.5 million of aggregate principal amount of Notes (the “Second Tranche Notes”).
On November 23, 2022, the First Tranche Notes converted into an aggregate of 15,000,000 shares of our common stock, at a priceand on November 25, 2022 the Second Tranche Notes converted into an aggregate of $18.00 per share, resulting821,299 shares of our common stock, in net proceedseach case pursuant to the Note Purchase Agreement. Following such conversion, the PSC Stockholder beneficially owned approximately 76.3% of $148.5 million after deducting underwriting discounts, commissions and offering expenses.
As of December 31, 2021,2022, we had cash and cash equivalents of $110.5$101.2 million, which are available to fund operations,our operations. Cash and cash equivalents include amounts deposited in financial institutions regulated by the FDIC. The FDIC insures cash deposits of up to $250,000. We regularly maintain cash balances in deposit accounts in excess of the FDIC insured limits. Additionally, our cash equivalents are held in accordance with cash sweep arrangements with financial institutions, which amounts are invested in money market accounts that are neither included on the balance sheets of such financial institutions nor insured by the FDIC. According to our cash sweep arrangements, we believe we should be recognized by the FDIC as the owner of such assets in the event of such financial institution’s failure, such as the March 10, 2023 closure of SVB. While we have regained access to our funds at SVB and are evaluating our banking relationships, future disruptions of financial institutions where we bank or disruptions of the financial services industry in general could adversely affect our ability to access our cash and cash equivalents. If we are unable to access our cash and cash equivalents as needed, our financial position and ability to operate our business could be adversely affected. In addition, even if we lack exposure to the uncertainty or volatility of one or more financial institutions, the impact of financial institution volatility on our partners, customers or suppliers may also impact our business and financial condition.
Our net losses were $157.5 million, $157.8 million and $39.9 million for the years ended December 31, 2022, 2021 and 2020, respectively. We had an accumulated deficit of $356.8 million.
72
We anticipate our future operating requirements will be substantial and that we will need to raise significant additional resources to fund our operations through equity or debt financing, or some combination thereof. We are currently exploring fundraising opportunities to meet these capital requirements. If we are unable to raise additional funding to meet our operational needs, we will be forced to limit or cease our operations.
In addition to our current capital needs, we regularly consider fundraising opportunities and may decide, from time to time, to raise capital based on various factors, including market conditions and our plans of operation. We may seek funds through borrowings or through additional rounds of financing, including private or public equity or debt offerings. AdditionalUncertainty in the market generally due to increasing interest rates and inflation may make it challenging to raise additional capital, and such capital may not be available to us on acceptable terms on a timely basis, or at all. If adequate funds are not available, or if the terms of potential funding sources are unfavorable, our business and our ability to develop our technology and our products would be harmed. Furthermore, any new equity or convertible debt securities we issue may result in the dilution of our stockholders, and any debt financing may include covenants that restrict our business.
Our longer termexpected future capital requirements and ability to raise additional capital will depend on many forward-looking factors, and areincluding but not limited to the following:
Our liquidity is subject to various risks, including the risks identified in the section titled “Risk Factors” in Item 1A of Part I. While the extent to which we are able to validate and establish additional processes to support the submission of claims for reimbursement to health plans, including those under the FEHB program, if at all, in the future, and the future impacts of the anticipated implementation of a pendingthe FDA’s new OTC hearing aid regulatory framework (which may lead insurance providers to take actions limiting our ability to access insurance coverage and may also generally result in additional compliance or other regulatory requirements for Eargo)coverage) are difficult to assess or predict at this time, since the announcement of the DOJ investigation and our related decision to temporarily stop accepting
Payments due by period | ||||||||||||||||||||
(in thousands) | Total | Less than 1 year | 1-3 years | 3-5 years | More than 5 years | |||||||||||||||
Operating lease obligations | $ | 9,832 | $ | 1,327 | $ | 2,195 | $ | 2,703 | $ | 3,607 | ||||||||||
Debt, principal and interest (1) | 17,016 | 3,950 | 13,066 | — | — | |||||||||||||||
Total | $ | 26,848 | $ | 5,277 | $ | 15,261 | $ | 2,703 | $ | 3,607 | ||||||||||
73
Cash flows
The following table summarizes our cash flows for the periods indicated:
Year ended December 31, | ||||||||
(in thousands) | 2021 | 2020 | ||||||
Net cash used in operating activities | $ | (98,456 | ) | $ | (26,041 | ) | ||
Net cash used in investing activities | (7,587 | ) | (5,079 | ) | ||||
Net cash provided by financing activities | 4,358 | 229,921 | ||||||
Net increase (decrease) in cash | $ | (101,685 | ) | $ | 198,801 | |||
|
| Twelve months ended December 31, |
| |||||
(in thousands) |
| 2022 |
|
| 2021 |
| ||
Net cash used in operating activities |
| $ | (117,304 | ) |
| $ | (98,456 | ) |
Net cash used in investing activities |
|
| (3,087 | ) |
|
| (7,587 | ) |
Net cash provided by financing activities |
|
| 111,129 |
|
|
| 4,358 |
|
Net decrease in cash and cash equivalents |
| $ | (9,262 | ) |
| $ | (101,685 | ) |
Operating activities
In 2022, cash used in operating activities was $117.3 million, attributable to a net loss of $157.5 million, partially offset by non-cash charges of $69.4 million and a net change in our net operating assets and liabilities of $29.2 million. Non-cash charges primarily consisted of $45.5 million related to the change in fair value of convertible notes, $10.0 million in stock-based compensation, $5.7 million in debt issuance costs from convertible notes, $5.5 million in depreciation and amortization expense, $1.1 million in non-cash operating lease expense, $0.8 million in loss on extinguishment of debt, and $0.7 million in bad debt expense. The change in our net operating assets and liabilities was primarily due to the payment of $34.4 million settlement liability associated with the DOJ investigation, a $9.9 million decrease in sales returns reserve and a $2.8 million decrease in accounts payable. These changes were partially offset by a $9.9 million decrease in accounts receivable, a $4.3 million decrease in prepaid expenses and other current and noncurrent assets, a $3.7 million increase in accrued expenses and a $0.7 million decrease in inventories.
In 2021, cash used in operating activities was $98.5 million, attributable to a net loss of $157.8 million, partially offset by
Investing activities
In 2020,2022, cash used in operatinginvesting activities was $26.0$3.1 million, attributable to a net loss of $39.9 million and a net change in our net operating assets and liabilities of $1.9 million, partially offset bynon-cashcharges of $15.7 million.Non-cashcharges primarilywhich consisted of $5.1$2.8 million related to the purchase of property and equipment and $0.3 million in stock-based compensation, $2.5 million in depreciation and amortization, $2.4 million in bad debt expensepayments for costs related to our insurance payment channel, $1.6 million in loss on extinguishmentthe development of debt, $1.5 million innon-cashinterest expense and amortization of debt discount, $1.5 million from the change in fair value of financial instruments primarily due to the change in fair value of our warrant liability and $1.1 million innon-cashoperating lease expense. The change in our net operating assets and liabilities was primarily due to a $4.1 million increase in accounts receivable related to an increase sales volume and growth in customers with health insurance coverage, a $1.6 million increase in prepaid expenses and other current and noncurrent assets primarily related to an increase in prepaid insurance, and a $1.2 million decrease in lease liabilities. These changes were partially offset by a $3.9 million increase in accrued expenses primarily related to an increase in accrued compensation, a $0.6 million increase in sales returns reserve, a $0.2 million increase in other current and noncurrent liabilities and a $0.2 million increase in accounts payable.
In 2021, cash used in investing activities was $7.6 million, which consisted of $3.8 million in capitalized costs related to the development of internal use software, $2.9 million in cash paid for acquisition of a business, and $0.9 million related to the purchase of property and equipment.
Financing activities
In 2020,2022, cash used in investingprovided by financing activities was $5.1 million, which consisted of $3.5$111.1 million. This was primarily attributable to $99.7 million in capitalized costs relatednet proceeds from issuance of the Notes and $27.6 million in net proceeds from issuance of our common stock upon the Rights Offering closing, offset by $16.2 million relating to the developmentrepayment of internal use software and $1.6 million related tolong-term debt under the purchase of property and equipment.
In 2021, cash provided by financing activities was $4.4 million. This was primarily attributable to $2.7 million from employee stock purchase plan purchases and $1.7 million from the exercise of stock options.
Critical accounting estimates
Management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. Our significant accounting policies and methods used in the preparation of our consolidated financial statements are described in Note 2 of the Notes to Consolidated Financial Statements included in Part II, Item 8 of this Annual Report on Form
The preparation of thesethe consolidated financial statements requires us to make estimates and assumptions regarding the reported amounts of assets, liabilities, revenue, expenses and related disclosures. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. The estimates, assumptions and judgments described below involve a substantial level of estimation uncertainty and as a result have had or are reasonably likely to have a material impact on our consolidated financial statements, results of operations and financial condition. Actual results may differ from these estimates under different assumptions or conditions and any such differences may be material.
74
Revenue recognition—sales returns reserve
Revenue is recorded net of expected returns, which are estimated based on analysis of various factors including historical returns, current economic trends, and changes in customer demand.
As of December 31, 20212022 and 2020,2021, we recorded a sales returns reserve of $13.8$3.9 million and $4.3$13.8 million, respectively, in the consolidated balance sheets. We recorded $37.7$18.2 million of estimated sales returns as a reduction in revenue during 20212022 based on our estimated returns of products sold during the year, which includes $13.3 million recorded during the third quarter of 2021 primarily based on our estimate that a majority of customers with unsubmitted claims will choose to return the hearing aid system if their insurance provider denies their claim or the claim is ultimately not submitted by us for payment (as further described in “—DOJ investigation and settlement and claims audits”). See also the caption “Sales returns reserve” under Note 4 of the Notes to the Consolidated Financial Statements included in this Annual Report on Form 10-K. The estimated sales returns recorded during the third quarter of 2021 included $5.1 million related to transactions that occurred during the first and second quarters of 2021. These estimates are inherently subject to estimation uncertainty because they assume the potential actions that a substantial number of our insurance pay customers may take as a result of the unavailability of insurance benefits as a direct payment method, which increases the probability of higher returns. If actual returns differ from our estimates or new factors arise indicating a rate of return that is different from our original estimate, an adjustment to revenue in a subsequent period will be recorded, which could have a material impact on our results of operations.
Accounts receivable—estimated credit losses
Accounts receivable is recorded net of an allowance for expected credit losses, which is based on our historical collection experience, current and future economic market conditions and a review of the current aging status and financial condition of our customers.
As of December 31, 20212022 and 2020,2021, we recorded an allowance for credit losses of $4.8$0.2 million and $1.9$4.8 million, respectively, in the consolidated balance sheets. We recorded $0.7 million and $9.6 million in bad debt expense during the yearyears ended December 31, 2022 and 2021, respectively. Bad debt expense recorded in 2021 was primarily based on our estimate that, in addition to the customers who choose to return their hearing aid systems, a significant number of customers with an extended right of return whose claims are denied by insurance providers or are not submitted by us for payment may not pay for or return the hearing aid system. Of the $9.6 million recorded to bad debt expense during the year ended December 31, 2021, $5.8 million relates to submitted claims that have been denied or have not been paid and waswere written off during 2021. During the year ended December 31, 2022, we released $4.5 million from the allowance for credit losses balance as part of the Pricing Concession. See the captioncaptions “DOJ investigation and settlement and claims audits” and “Allowance for credit losses” under Note 4 ofin the Notes 1 and 4 to theour Consolidated Financial Statements included in this Annual Report on Form 10-K.
As similarly described in “—“Revenue recognition—sales returns reserve” above, estimates with respect to the actions of our customers, in this case relating to
Stock-based compensation—valuation of equity awards
The valuation model used for calculating the estimated fair value of stock options and purchase rights granted under the employee stock purchase plan is the Black-Scholes option-pricing model. The Black-Scholes model requires us to make assumptions and judgments about the variables used in the calculations, including the expected term (weighted-average period of time that the stock-based awards are expected to be outstanding), the expected volatility of our common stock, the related risk-free interest rate and the expected dividend. We have elected to recognize forfeitures of stock options as they occur.
The Black-Scholes option-pricing model requires the use of highly subjective assumptions which determine the fair value of stock-based awards. These assumptions include:
75
Recent accounting pronouncements
See Note 2 to our consolidated financial statements appearing under Part II, Item 8 for more information about recent accounting pronouncements, the timing of their adoption, and our assessment.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Interest rate risk
Our cash and cash equivalents as of December 31, 20212022 consists of $110.5$101.2 million in bank deposits and money market funds. Such interest-earning instruments carry a degree of interest rate risk. The goals of our investment policy are liquidity and capital preservation; we do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate exposure. We believe that we do not have any material exposure to changes in the fair value of these assets as a result of changes in interest rates due to the short-term nature of our cash and cash equivalents.
As of December 31, 2021, we had $15.0 million in variable rate debt outstanding. TheOn June 28, 2022 in connection with the Note Transaction, we repaid all amounts outstanding and terminated the 2018 Loan matures in September 2024 and has interest-only payments until July 2022. The 2018 Loan accrues interest at a floating per annum rate equal to the Wall Street Journal prime rate plus 1.00% with a floor of 0.00% (4.25% asAgreement. As of December 31, 2021). A hypothetical increase or decrease of 100 basis points2022, we had no debt outstanding. Refer to Note 8 to our Consolidated Financial Statements included in this Annual Report on Form 10-K for more information regarding the aforementioned prime rate would not have a material impact on our financial position or results of operations.
76
Item 8. Financial Statements and Supplementary Data.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
78 | ||||
80 | ||||
81 | ||||
82 | ||||
84 | ||||
85 |
77
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the shareholdersstockholders and the Board of Directors of Eargo, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Eargo, Inc. and subsidiaries (the “Company”"Company") as of December 31, 20212022 and 2020,2021, the related consolidated statements of operations and comprehensive loss, convertible preferred stock and shareholders’stockholders' equity, (deficit), and cash flows for each of the three years in the period ended December 31, 2021,2022, and the related notes (collectively referred to as the “financial statements”"financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 20212022 and 2020,2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2021,2022, in conformity with accounting principles generally accepted in the United States of America.
Going Concern
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the financial statements, the Company’sCompany's losses, negative cash flows and current lack of financial resources raise substantial doubt about its ability to continue as a going concern. Management’sManagement's plans in regard to these matters are also described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These financial statements are the responsibility of the Company’sCompany's management. Our responsibility is to express an opinion on the Company’sCompany's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit mattermatters communicated below is a matterare matters arising from the current-period audit of the financial statements that waswere communicated or required to be communicated to the audit committee and that (1) relatesrelate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit mattermatters below, providing a separate opinionopinions on the critical audit mattermatters or on the accounts or disclosures to which it relates.
Description of Business and other matters – Insurance matters related to revenue recognition, sales returns reserve, and allowance for credit lossesPricing Concession – Refer to Notes 1, 2, and 4 to the financial statements
Critical Audit Matter Description
As of December 31, 2021, the criteria for revenue recognition under Accounting Standard Codification Topic 606,Revenue from Contracts with Customers(“ASC 606”) after September 21, 2021. The Company recorded a sales returns reserve as a result of an offer to customers with potential insurance coverage the option to return their hearing aids. The Company also recorded an allowance for credit losses related to all outstanding insurance claims receivable as of December 31, 2021,2021.
78
In September 2022, the Company made the determination not to seek payment for approximately $16.1 million from customers with unsubmitted and unpaid insurance claims for customers with potential insurance coverage, which was accounted for as a result of the uncertainty pertaining to insurance claims reimbursement.
We identified management’s accounting evaluation and conclusions around revenue recognition, sales returns reserve, and allowance for credit losses associated with product shipments with potential insurance coveragethe Pricing Concession as a critical audit matter due to the significant judgments required by management to appropriately account for these transactions.the Pricing Concession. This required a high degree of auditor judgment and an increased extent of effort, including the involvement of professionals in our firm having expertise in revenue recognition and receivables when performing audit procedures to evaluate the accounting conclusions and amounts recorded.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the accounting evaluation and conclusions around revenue recognition, sales returns reserve, and allowance for credit lossesthe Pricing Concession related to product shipments with potentialunsubmitted and unpaid insurance coverageclaims included the following, among others:
Rights Offering and debt obligations – the Notes – Refer to Notes 1, 2, 3, and 8 to the financial statements
Critical Audit Matter Description
The Company entered into a note purchase agreement with Patient Square Capital (“PSC”) in June of 2022. This agreement contained the right for PSC to convert their debt into equity. The Company elected to use the fair value option to account for the notes that were issued in June 2022 and remeasured the underlying liability through the notes conversion on November 23 and 25, 2022.
We identified the accounting related to the issuance and reacquisition of the notes to be a critical audit matter due to the significant judgments required by management to calculate its sales returns reserveappropriately account for the issuance and allowance for credit lossesreacquisition of the notes. This required a high degree of auditor judgment and an increased extent of effort, including the involvement of professionals in our firm having expertise in debt and financial instruments when performing audit procedures to evaluate the accounting conclusions and amounts recorded.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to product shipmentsthe accounting evaluation related to the issuance and reacquisition of the notes included the following, among others:
/s/ Deloitte & Touche LLP
San Jose, California
March 23, 2023
We have served as the Company’s auditor since 2018.
79
Eargo, Inc.
Consolidated Balance Sheets
(
December 31, 2021 | December 31, 2020 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash and cash equivalents | $ | 110,500 | $ | 212,185 | ||||
Accounts receivable, net | 12,547 | 3,793 | ||||||
Inventories | 5,712 | 2,739 | ||||||
Prepaid expenses and other current assets | 10,873 | 3,740 | ||||||
Total current assets | 139,632 | 222,457 | ||||||
Operating lease right-of-use | 7,165 | 1,079 | ||||||
Property and equipment, net | 9,551 | 8,034 | ||||||
Intangible assets, net | 1,681 | 0 | ||||||
Goodwill | 873 | 0 | ||||||
Other assets | 1,209 | 1,062 | ||||||
Total assets | $ | 160,111 | $ | 232,632 | ||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||
Current liabilities: | ||||||||
Accounts payable | $ | 9,053 | $ | 6,020 | ||||
Accrued expenses | 9,235 | 9,583 | ||||||
Sales returns reserve | 13,827 | 4,326 | ||||||
Settlement liability | 34,372 | 0 | ||||||
Long-term debt, current portion | 3,333 | 0 | ||||||
Other current liabilities | 1,813 | 2,448 | ||||||
Deferred revenue, current portion | 0 | 311 | ||||||
Lease liability, current portion | 750 | 1,030 | ||||||
Total current liabilities | 72,383 | 23,718 | ||||||
Lease liability, noncurrent portion | 6,640 | 166 | ||||||
Long-term debt, noncurrent portion | 11,924 | 14,837 | ||||||
Total liabilities | 90,947 | 38,721 | ||||||
Commitments and contingencies (Note 6) | 0 | 0 | ||||||
Stockholders’ equity: | ||||||||
Preferred stock, $0.0001 par value per share; 5,000,000 shares authorized as of December 31, 2021 and 2020, respectively; 0 shares issued and outstanding as of December 31, 2021 and 2020, respectively | 0 | 0 | ||||||
Common stock; $0.0001 par value; 110,000,000 shares authorized as of December 31, 2021 and 2020, respectively; 39,307,093 and 38,246,601 shares issued and outstanding as of December 31, 2021 and 2020, respectively | 4 | 4 | ||||||
Additional paid-in capital | 425,972 | 392,965 | ||||||
Accumulated deficit | (356,812 | ) | (199,058 | ) | ||||
Total stockholders’ equity | 69,164 | 193,911 | ||||||
Total liabilities and stockholders’ equity | $ | 160,111 | $ | 232,632 | ||||
|
| December 31, |
|
| December 31, |
| ||
|
| 2022 |
|
| 2021 |
| ||
ASSETS |
|
|
|
|
|
| ||
Current assets: |
|
|
|
|
|
| ||
Cash and cash equivalents |
| $ | 101,238 |
|
| $ | 110,500 |
|
Accounts receivable, net |
|
| 1,910 |
|
|
| 12,547 |
|
Inventories |
|
| 5,036 |
|
|
| 5,712 |
|
Prepaid expenses and other current assets |
|
| 7,846 |
|
|
| 10,873 |
|
Total current assets |
|
| 116,030 |
|
|
| 139,632 |
|
Operating lease right-of-use assets |
|
| 5,765 |
|
|
| 7,165 |
|
Property and equipment, net |
|
| 7,441 |
|
|
| 9,551 |
|
Intangible assets, net |
|
| 1,063 |
|
|
| 1,681 |
|
Goodwill |
|
| 873 |
|
|
| 873 |
|
Other assets |
|
| 906 |
|
|
| 1,209 |
|
Total assets |
| $ | 132,078 |
|
| $ | 160,111 |
|
LIABILITIES AND STOCKHOLDERS’ EQUITY |
|
|
|
|
|
| ||
Current liabilities: |
|
|
|
|
|
| ||
Accounts payable |
| $ | 6,504 |
|
| $ | 9,053 |
|
Accrued expenses |
|
| 12,715 |
|
|
| 9,235 |
|
Sales returns reserve |
|
| 3,942 |
|
|
| 13,827 |
|
Settlement liability |
|
| — |
|
|
| 34,372 |
|
Long-term debt, current portion |
|
| — |
|
|
| 3,333 |
|
Other current liabilities |
|
| 1,462 |
|
|
| 1,813 |
|
Lease liability, current portion |
|
| 628 |
|
|
| 750 |
|
Total current liabilities |
|
| 25,251 |
|
|
| 72,383 |
|
Lease liability, noncurrent portion |
|
| 5,973 |
|
|
| 6,640 |
|
Long-term debt, noncurrent portion |
|
| — |
|
|
| 11,924 |
|
Total liabilities |
|
| 31,224 |
|
|
| 90,947 |
|
Commitments and contingencies (Note 6) |
|
|
|
|
|
| ||
Stockholders’ equity: |
|
|
|
|
|
| ||
Preferred stock, $0.0001 par value per share; 5,000,000 shares authorized |
|
| — |
|
|
| — |
|
Common stock; $0.0001 par value; 450,000,000 and 110,000,000 shares |
|
| 2 |
|
|
| — |
|
Additional paid-in capital |
|
| 615,151 |
|
|
| 425,976 |
|
Accumulated deficit |
|
| (514,299 | ) |
|
| (356,812 | ) |
Total stockholders’ equity |
|
| 100,854 |
|
|
| 69,164 |
|
Total liabilities and stockholders’ equity |
| $ | 132,078 |
|
| $ | 160,111 |
|
The accompanying notes are an integral part of these consolidated financial statements.
80
Eargo, Inc.
Consolidated Statements of Operations and Comprehensive Loss
(
Year ended December 31, | ||||||||||||
2021 | 2020 | 2019 | ||||||||||
Revenue, net | $ | 32,122 | $ | 69,154 | $ | 32,790 | ||||||
Cost of revenue | 27,956 | 21,873 | 15,790 | |||||||||
Gross profit | 4,166 | 47,281 | 17,000 | |||||||||
Operating expenses: | ||||||||||||
Research and development | 25,232 | 12,045 | 12,841 | |||||||||
Sales and marketing | 85,759 | 49,525 | 35,725 | |||||||||
General and administrative | 49,882 | 20,582 | 12,470 | |||||||||
Total operating expenses | 160,873 | 82,152 | 61,036 | |||||||||
Loss from operations | (156,707 | ) | (34,871 | ) | (44,036 | ) | ||||||
Other income (expense), net: | ||||||||||||
Interest income | 21 | 37 | 627 | |||||||||
Interest expense | (1,068 | ) | (1,920 | ) | (711 | ) | ||||||
Other income (expense), net | 0 | (1,474 | ) | (366 | ) | |||||||
Loss on extinguishment of debt | 0 | (1,627 | ) | 0 | ||||||||
Total other income (expense), net | (1,047 | ) | (4,984 | ) | (450 | ) | ||||||
Loss before income taxes | (157,754 | ) | (39,855 | ) | (44,486 | ) | ||||||
Income tax provision | 0 | 0 | 0 | |||||||||
Net loss and comprehensive loss | $ | (157,754 | ) | $ | (39,855 | ) | $ | (44,486 | ) | |||
Net loss attributable to common stockholders, basic and diluted | $ | (157,754 | ) | $ | (30,015 | ) | $ | (44,486 | ) | |||
Net loss per share attributable to common stockholders, basic and diluted | $ | (4.06 | ) | $ | (3.80 | ) | $ | (173.47 | ) | |||
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted | 38,899,457 | 7,890,375 | 256,452 | |||||||||
|
| Year ended December 31, |
| |||||||||
|
| 2022 |
|
| 2021 |
|
| 2020 |
| |||
Revenue, net |
| $ | 37,248 |
|
| $ | 32,122 |
|
| $ | 69,154 |
|
Cost of revenue |
|
| 22,988 |
|
|
| 27,956 |
|
|
| 21,873 |
|
Gross profit |
|
| 14,260 |
|
|
| 4,166 |
|
|
| 47,281 |
|
Operating expenses: |
|
|
|
|
|
|
|
|
| |||
Research and development |
|
| 18,813 |
|
|
| 25,232 |
|
|
| 12,045 |
|
Sales and marketing |
|
| 52,947 |
|
|
| 85,759 |
|
|
| 49,525 |
|
General and administrative |
|
| 54,259 |
|
|
| 49,882 |
|
|
| 20,582 |
|
Total operating expenses |
|
| 126,019 |
|
|
| 160,873 |
|
|
| 82,152 |
|
Loss from operations |
|
| (111,759 | ) |
|
| (156,707 | ) |
|
| (34,871 | ) |
Other income (expense), net: |
|
|
|
|
|
|
|
|
| |||
Interest income |
|
| 1,196 |
|
|
| 21 |
|
|
| 37 |
|
Interest expense |
|
| (549 | ) |
|
| (1,068 | ) |
|
| (1,920 | ) |
Other income (expense), net |
|
| — |
|
|
| — |
|
|
| (1,474 | ) |
Change in fair value of convertible notes |
|
| (45,503 | ) |
|
| — |
|
|
| — |
|
Loss on extinguishment of debt |
|
| (772 | ) |
|
| — |
|
|
| (1,627 | ) |
Total other income (expense), net |
|
| (45,628 | ) |
|
| (1,047 | ) |
|
| (4,984 | ) |
Loss before income taxes |
|
| (157,387 | ) |
|
| (157,754 | ) |
|
| (39,855 | ) |
Income tax provision |
|
| 100 |
|
|
| — |
|
|
| — |
|
Net loss and comprehensive loss |
| $ | (157,487 | ) |
| $ | (157,754 | ) |
| $ | (39,855 | ) |
Gain on extinguishment of Series C and Series C-1 convertible preferred stock |
|
| — |
|
|
| — |
|
|
| 9,840 |
|
Net loss attributable to common stockholders, basic and diluted |
| $ | (157,487 | ) |
| $ | (157,754 | ) |
| $ | (30,015 | ) |
Net loss per share attributable to common stockholders, basic and diluted |
| $ | (39.68 | ) |
| $ | (81.11 | ) |
| $ | (76.10 | ) |
Weighted-average shares used in computing net loss per share |
|
| 3,968,432 |
|
|
| 1,944,857 |
|
|
| 394,405 |
|
The accompanying notes are an integral part of these consolidated financial statements.
81
Eargo, Inc.
Consolidated Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit)
(
Convertible preferred stock | Common stock | Additional paid-in capital | Accumulated deficit | Total stockholders’ equity (deficit) | ||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | |||||||||||||||||||||||||||||
Balance December 31, 2018 | 11,761,159 | $ | 152,015 | 231,831 | $ | 0 | $ | 1,718 | $ | (114,717 | ) | $ | (112,999 | ) | ||||||||||||||||||
Issuance of Series D convertible preferred stock, net of issuance costs of $0 | 64,653 | 865 | — | — | — | — | — | |||||||||||||||||||||||||
Stock-based compensation | — | — | — | — | 1,339 | — | 1,339 | |||||||||||||||||||||||||
Exercise of stock options | — | — | 34,112 | — | 43 | — | 43 | |||||||||||||||||||||||||
Net loss and comprehensive loss | — | — | — | — | — | (44,486 | ) | (44,486 | ) | |||||||||||||||||||||||
Balance December 31, 2019 | 11,825,812 | 152,880 | 265,943 | — | 3,100 | (159,203 | ) | (156,103 | ) | |||||||||||||||||||||||
Issuance of Series E convertible preferred stock, net of issuance costs of $4,056 | 10,513,921 | 67,267 | — | — | — | — | — | |||||||||||||||||||||||||
Issuance of Series E convertible preferred stock, upon extinguishment of convertible notes | 1,889,548 | 12,818 | — | — | — | — | — | |||||||||||||||||||||||||
Gain on extinguishment of Series C and Series C-1 convertible preferred stock | — | (9,840 | ) | — | — | 9,840 | — | 9,840 | ||||||||||||||||||||||||
Conversion of convertible preferred stock to common stock upon initial public offering | (24,229,281 | ) | (223,125 | ) | 28,196,388 | 3 | 223,122 | — | 223,125 | |||||||||||||||||||||||
Conversion of convertible preferred stock warrants to common stock warrants upon initial public offering | — | — | — | — | 1,931 | — | 1,931 | |||||||||||||||||||||||||
Issuance of common stock upon initial public offering, net of underwriting discounts and commissions and other offering costs of $14,031 | — | — | 9,029,629 | 1 | 148,501 | — | 148,502 | |||||||||||||||||||||||||
Exercise of common stock warrants | — | — | 107,790 | — | — | — | — | |||||||||||||||||||||||||
Stock-based compensation | — | — | — | — | 5,292 | — | 5,292 | |||||||||||||||||||||||||
Exercise of stock options | — | — | 646,851 | — | 1,179 | — | 1,179 | |||||||||||||||||||||||||
Net loss and comprehensive loss | — | — | — | — | — | (39,855 | ) | (39,855 | ) | |||||||||||||||||||||||
Balance December 31, 2020 | 0 | 0 | 38,246,601 | 4 | 392,965 | (199,058 | ) | 193,911 | ||||||||||||||||||||||||
Stock-based compensation | — | — | — | — | 28,609 | — | 28,609 | |||||||||||||||||||||||||
Exercise of stock options and release of restricted stock units | — | — | 885,749 | — | 1,724 | — | 1,724 | |||||||||||||||||||||||||
Issuance of common stock in connection with employee stock purchase plan | — | — | 174,743 | — | 2,674 | — | 2,674 | |||||||||||||||||||||||||
Net loss and comprehensive loss | — | — | — | — | — | (157,754 | ) | (157,754 | ) | |||||||||||||||||||||||
Balance December 31, 2021 | 0 | $ | 0 | 39,307,093 | $ | 4 | $ | 425,972 | $ | (356,812 | ) | $ | 69,164 | |||||||||||||||||||
82
|
| Convertible preferred stock |
|
|
| Common stock |
|
| Additional |
|
| Accumulated |
|
| Total |
| |||||||||||||
|
| Shares |
|
| Amount |
|
|
| Shares |
|
| Amount |
|
| capital |
|
| deficit |
|
| equity (deficit) |
| |||||||
Balance December 31, 2019 |
|
| 591,290 |
|
| $ | 152,880 |
|
|
|
| 13,297 |
|
| $ | — |
|
| $ | 3,100 |
|
| $ | (159,203 | ) |
| $ | (156,103 | ) |
Issuance of Series E convertible preferred stock, |
|
| 525,696 |
|
|
| 67,267 |
|
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
Issuance of Series E convertible preferred stock |
|
| 94,477 |
|
|
| 12,818 |
|
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
Gain on extinguishment of Series C and Series C-1 convertible preferred stock |
|
| — |
|
|
| (9,840 | ) |
|
|
| — |
|
|
| — |
|
|
| 9,840 |
|
|
| — |
|
|
| 9,840 |
|
Conversion of convertible preferred stock to common stock upon initial public offering |
|
| (1,211,463 | ) |
|
| (223,125 | ) |
|
|
| 1,409,819 |
|
|
| — |
|
|
| 223,125 |
|
|
| — |
|
|
| 223,125 |
|
Conversion of convertible preferred stock warrants to common stock warrants upon initial public offering |
|
| — |
|
|
| — |
|
|
|
| — |
|
|
| — |
|
|
| 1,931 |
|
|
| — |
|
|
| 1,931 |
|
Issuance of common stock upon initial public offering, net of underwriting discounts and commissions and other offering costs of $14,031 |
|
| — |
|
|
| — |
|
|
|
| 451,481 |
|
|
| — |
|
|
| 148,502 |
|
|
| — |
|
|
| 148,502 |
|
Exercise of common stock warrants |
|
| — |
|
|
| — |
|
|
|
| 5,389 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
Stock-based compensation |
|
| — |
|
|
| — |
|
|
|
| — |
|
|
| — |
|
|
| 5,292 |
|
|
| — |
|
|
| 5,292 |
|
Exercise of stock options |
|
| — |
|
|
| — |
|
|
|
| 32,340 |
|
|
| — |
|
|
| 1,179 |
|
|
| — |
|
|
| 1,179 |
|
Net loss and comprehensive loss |
|
| — |
|
|
| — |
|
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (39,855 | ) |
|
| (39,855 | ) |
Balance December 31, 2020 |
|
| — |
|
|
| — |
|
|
|
| 1,912,326 |
|
|
| — |
|
|
| 392,969 |
|
|
| (199,058 | ) |
|
| 193,911 |
|
Stock-based compensation |
|
| — |
|
|
| — |
|
|
|
| — |
|
|
| — |
|
|
| 28,609 |
|
|
| — |
|
|
| 28,609 |
|
Exercise of stock options and release of |
|
| — |
|
|
| — |
|
|
|
| 44,284 |
|
|
| — |
|
|
| 1,724 |
|
|
| — |
|
|
| 1,724 |
|
Issuance of common stock in connection |
|
| — |
|
|
| — |
|
|
|
| 8,737 |
|
|
| — |
|
|
| 2,674 |
|
|
| — |
|
|
| 2,674 |
|
Net loss and comprehensive loss |
|
| — |
|
|
| — |
|
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (157,754 | ) |
|
| (157,754 | ) |
Balance December 31, 2021 |
|
| — |
|
|
| — |
|
|
|
| 1,965,347 |
|
|
| — |
|
|
| 425,976 |
|
|
| (356,812 | ) |
|
| 69,164 |
|
Stock-based compensation |
|
| — |
|
|
| — |
|
|
|
| — |
|
|
| — |
|
|
| 9,965 |
|
|
| — |
|
|
| 9,965 |
|
Exercise of stock options and release of |
|
| — |
|
|
| — |
|
|
|
| 11,618 |
|
|
| — |
|
|
| 65 |
|
|
| — |
|
|
| 65 |
|
Tax withholdings on settlement of |
|
| — |
|
|
| — |
|
|
|
| — |
|
|
| — |
|
|
| (29 | ) |
|
| — |
|
|
| (29 | ) |
Issuance costs |
|
| — |
|
|
| — |
|
|
|
| — |
|
|
| — |
|
|
| 600 |
|
|
| — |
|
|
| 600 |
|
Conversion of convertible notes |
|
| — |
|
|
| — |
|
|
|
| 15,821,299 |
|
|
| 2 |
|
|
| 150,976 |
|
|
| — |
|
|
| 150,978 |
|
Issuance of common stock upon rights offering, net of issuance costs of $1,689 |
|
| — |
|
|
| — |
|
|
|
| 2,928,701 |
|
|
| — |
|
|
| 27,598 |
|
|
| — |
|
|
| 27,598 |
|
Net loss and comprehensive loss |
|
| — |
|
|
| — |
|
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (157,487 | ) |
|
| (157,487 | ) |
Balance December 31, 2022 |
|
| — |
|
| $ | — |
|
|
|
| 20,726,965 |
|
| $ | 2 |
|
| $ | 615,151 |
|
| $ | (514,299 | ) |
| $ | 100,854 |
|
The accompanying notes are an integral part of these consolidated financial statements.
Eargo, Inc.
Consolidated Statements of Cash Flows
(
Year ended December 31, | ||||||||||||
2021 | 2020 | 2019 | ||||||||||
Operating activities: | ||||||||||||
Net loss | $ | (157,754 | ) | $ | (39,855 | ) | $ | (44,486 | ) | |||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||||||
Depreciation and amortization | 4,202 | 2,525 | 1,528 | |||||||||
Stock-based compensation | 27,731 | 5,089 | 1,339 | |||||||||
Non-cash interest expense and amortization of debt discount | 420 | 1,513 | 297 | |||||||||
Non-cash operating lease expense | 1,063 | 1,128 | 0 | |||||||||
Bad debt expense | 9,615 | 2,352 | 313 | |||||||||
Loss on disposal of property and equipment | 155 | 0 | 24 | |||||||||
Loss on extinguishment of debt | 0 | 1,627 | 0 | |||||||||
Change in fair value of financial instruments | 0 | 1,471 | 274 | |||||||||
Changes in operating assets and liabilities: | ||||||||||||
Accounts receivable | (18,369 | ) | (4,094 | ) | (1,399 | ) | ||||||
Inventories | (2,973 | ) | 141 | (720 | ) | |||||||
Prepaid expenses and other current and noncurrent assets | (7,383 | ) | (1,636 | ) | (641 | ) | ||||||
Accounts payable | 3,130 | 187 | 163 | |||||||||
Accrued expenses | (368 | ) | 3,900 | 2,692 | ||||||||
Sales returns reserve | 9,501 | 567 | 1,046 | |||||||||
Settlement liability | 34,372 | 0 | 0 | |||||||||
Other current and noncurrent liabilities | (946 | ) | 240 | 462 | ||||||||
Operating lease liabilities | (852 | ) | (1,196 | ) | 0 | |||||||
Net cash used in operating activities | (98,456 | ) | (26,041 | ) | (39,108 | ) | ||||||
Investing activities: | ||||||||||||
Purchases of property and equipment | (882 | ) | (1,624 | ) | (2,167 | ) | ||||||
Capitalized software development costs | (3,842 | ) | (3,455 | ) | (1,692 | ) | ||||||
Cash paid for acquisition of business | (2,863 | ) | 0 | 0 | ||||||||
Net cash used in investing activities | (7,587 | ) | (5,079 | ) | (3,859 | ) | ||||||
Financing activities: | ||||||||||||
Proceeds from stock options exercised | 1,724 | 1,179 | 43 | |||||||||
Proceeds from employee stock purchase plan purchases | 2,674 | 0 | 0 | |||||||||
Proceeds from issuance of common stock upon initial public offering, net of underwriting discounts and commissions | 0 | 151,156 | 0 | |||||||||
Payments of other offering costs related to the initial public offering | (40 | ) | (2,614 | ) | (758 | ) | ||||||
Proceeds from convertible preferred stock issuance, net of issuance costs | 0 | 67,867 | 865 | |||||||||
Proceeds from issuance of convertible notes, net of issuance costs | 0 | 10,053 | 0 | |||||||||
Proceeds from debt financing | 0 | 15,000 | 5,000 | |||||||||
Debt repayments | 0 | (12,720 | ) | 0 | ||||||||
Proceeds from PPP loan | 0 | 4,574 | 0 | |||||||||
Repayment of PPP loan | 0 | (4,574 | ) | 0 | ||||||||
Net cash provided by financing activities | 4,358 | 229,921 | 5,150 | |||||||||
Net increase (decrease) in cash and cash equivalents and restricted cash | (101,685 | ) | 198,801 | (37,817 | ) | |||||||
Cash and cash equivalents and restricted cash at beginning of period | 212,185 | 13,384 | 51,201 | |||||||||
Cash and cash equivalents and restricted cash at end of period | $ | 110,500 | $ | 212,185 | $ | 13,384 | ||||||
Supplemental disclosure of cash flow information: | ||||||||||||
Cash paid for taxes | $ | 107 | $ | 63 | $ | 0 | ||||||
Cash paid for interest | $ | 646 | $ | 398 | $ | 395 | ||||||
Non-cash operating activities: | ||||||||||||
Lease liability obtained in exchange for right-of-use | $ | 7,046 | $ | 2,392 | $ | 0 | ||||||
Non-cash investing and financing activities: | ||||||||||||
Property and equipment and capitalized software costs in accounts payable and accrued liabilities | $ | 357 | $ | 393 | $ | 515 | ||||||
Stock-based compensation included in capitalized software costs | $ | 878 | $ | 203 | $ | 0 | ||||||
Convertible preferred stock issuance costs included in accounts payable | $ | 600 | $ | 600 | $ | 0 | ||||||
Common stock issued on conversion of convertible preferred stock upon initial public offering | $ | 0 | $ | 223,125 | $ | 0 | ||||||
Conversion of convertible preferred stock warrants to common stock warrants and related reclassification of convertible preferred stock warrant liability to additional paid-in capital | $ | 0 | $ | 1,931 | $ | 0 | ||||||
Offering costs in accounts payable and accrued liabilities | $ | 0 | $ | 40 | $ | 424 | ||||||
Issuance of Series E convertible preferred stock upon extinguishment of convertible notes | $ | 0 | $ | 12,818 | $ | 0 | ||||||
|
| Year ended December 31, |
| |||||||||
|
| 2022 |
|
| 2021 |
|
| 2020 |
| |||
Operating activities: |
|
|
|
|
|
|
|
|
| |||
Net loss |
| $ | (157,487 | ) |
| $ | (157,754 | ) |
| $ | (39,855 | ) |
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
|
| |||
Depreciation and amortization |
|
| 5,458 |
|
|
| 4,202 |
|
|
| 2,525 |
|
Stock-based compensation |
|
| 9,965 |
|
|
| 27,731 |
|
|
| 5,089 |
|
Non-cash interest expense and amortization of debt discount |
|
| 209 |
|
|
| 420 |
|
|
| 1,513 |
|
Debt issuance costs from convertible notes |
|
| 5,742 |
|
|
| — |
|
|
| — |
|
Change in fair value of convertible notes |
|
| 45,503 |
|
|
| — |
|
|
| 1,471 |
|
Loss on extinguishment of debt |
|
| 772 |
|
|
| — |
|
|
| 1,627 |
|
Non-cash operating lease expense |
|
| 1,050 |
|
|
| 1,063 |
|
|
| 1,128 |
|
Bad debt expense |
|
| 713 |
|
|
| 9,615 |
|
|
| 2,352 |
|
Loss on disposal of property and equipment |
|
| — |
|
|
| 155 |
|
|
| — |
|
Changes in operating assets and liabilities: |
|
|
|
|
|
|
|
|
| |||
Accounts receivable |
|
| 9,924 |
|
|
| (18,369 | ) |
|
| (4,094 | ) |
Inventories |
|
| 676 |
|
|
| (2,973 | ) |
|
| 141 |
|
Prepaid expenses and other noncurrent and current assets |
|
| 4,277 |
|
|
| (7,383 | ) |
|
| (1,636 | ) |
Accounts payable |
|
| (2,794 | ) |
|
| 3,130 |
|
|
| 187 |
|
Accrued expenses |
|
| 3,735 |
|
|
| (368 | ) |
|
| 3,900 |
|
Sales returns reserve |
|
| (9,885 | ) |
|
| 9,501 |
|
|
| 567 |
|
Settlement liability |
|
| (34,372 | ) |
|
| 34,372 |
|
|
| — |
|
Other current and noncurrent liabilities |
|
| (351 | ) |
|
| (946 | ) |
|
| 240 |
|
Operating lease liabilities |
|
| (439 | ) |
|
| (852 | ) |
|
| (1,196 | ) |
Net cash used in operating activities |
|
| (117,304 | ) |
|
| (98,456 | ) |
|
| (26,041 | ) |
Investing activities: |
|
|
|
|
|
|
|
|
| |||
Purchases of property and equipment |
|
| (2,791 | ) |
|
| (882 | ) |
|
| (1,624 | ) |
Capitalized software development costs |
|
| (296 | ) |
|
| (3,842 | ) |
|
| (3,455 | ) |
Cash paid for acquisition of business |
|
| — |
|
|
| (2,863 | ) |
|
| - |
|
Net cash used in investing activities |
|
| (3,087 | ) |
|
| (7,587 | ) |
|
| (5,079 | ) |
Financing activities: |
|
|
|
|
|
|
|
|
| |||
Proceeds from issuance of convertible notes, net of issuance costs paid to lender |
|
| 105,378 |
|
|
| — |
|
|
| 10,053 |
|
Payment of convertible notes issuance costs to third parties |
|
| (5,645 | ) |
|
| — |
|
|
| — |
|
Proceeds from issuance of common stock upon rights offering, net of issuance costs |
|
| 27,598 |
|
|
| — |
|
|
| — |
|
Proceeds from convertible preferred stock issuance, net of issuance costs |
|
| — |
|
|
| — |
|
|
| 67,867 |
|
Proceeds from debt financing |
|
| — |
|
|
| — |
|
|
| 15,000 |
|
Debt repayments |
|
| (16,238 | ) |
|
| — |
|
|
| (12,720 | ) |
Proceeds from issuance of common stock upon initial public offering, |
|
| — |
|
|
| (40 | ) |
|
| 148,542 |
|
Proceeds from PPP loan |
|
| — |
|
|
| — |
|
|
| 4,574 |
|
Repayment of PPP loan |
|
| — |
|
|
| — |
|
|
| (4,574 | ) |
Proceeds from stock options exercised |
|
| 134 |
|
|
| 1,724 |
|
|
| 1,179 |
|
Proceeds from employee stock purchase plan purchases |
|
| — |
|
|
| 2,674 |
|
|
| — |
|
Payment of taxes related to net share settlement of restricted stock units |
|
| (29 | ) |
|
| — |
|
|
| — |
|
Restricted stock units settled in cash |
|
| (69 | ) |
|
| — |
|
|
| — |
|
Net cash provided by financing activities |
|
| 111,129 |
|
|
| 4,358 |
|
|
| 229,921 |
|
Net decrease in cash and cash equivalents |
|
| (9,262 | ) |
|
| (101,685 | ) |
|
| 198,801 |
|
Cash and cash equivalents at beginning of period |
|
| 110,500 |
|
|
| 212,185 |
|
|
| 13,384 |
|
Cash and cash equivalents at end of period |
| $ | 101,238 |
|
| $ | 110,500 |
|
| $ | 212,185 |
|
Supplemental disclosure of cash flow information: |
|
|
|
|
|
|
|
|
| |||
Cash paid for taxes |
| $ | 124 |
|
| $ | 107 |
|
| $ | 63 |
|
Cash paid for interest |
| $ | 396 |
|
| $ | 646 |
|
| $ | 398 |
|
Non-cash operating activities: |
|
|
|
|
|
|
|
|
| |||
Lease liability obtained in exchange for right-of-use asset |
| $ | — |
|
| $ | 7,046 |
|
| $ | 2,392 |
|
Non-cash investing and financing activities: |
|
|
|
|
|
|
|
|
| |||
Property and equipment and capitalized software costs in accounts payable and accrued liabilities |
| $ | — |
|
| $ | 357 |
|
| $ | 393 |
|
Stock-based compensation included in capitalized software costs |
| $ | — |
|
| $ | 878 |
|
| $ | 203 |
|
Convertible preferred stock issuance costs included in accounts payable |
| $ | — |
|
| $ | 600 |
|
| $ | 600 |
|
Common stock issued on conversion of convertible preferred stock upon |
| $ | — |
|
| $ | — |
|
| $ | 223,125 |
|
Common stock issued upon conversion of convertible notes |
| $ | 150,978 |
|
| $ | — |
|
| $ | — |
|
Conversion of convertible preferred stock warrants to common stock warrants |
| $ | — |
|
| $ | — |
|
| $ | 1,931 |
|
Offering costs in accounts payable and accrued liabilities |
| $ | — |
|
| $ | — |
|
| $ | 40 |
|
Issuance of Series E convertible preferred stock upon extinguishment of |
| $ | — |
|
| $ | — |
|
| $ | 12,818 |
|
The accompanying notes are an integral part of these consolidated financial statements.
84
Eargo, Inc.
Notes to Consolidated Financial Statements
Note 1. Description of business and other matters
Eargo, Inc. (the “Company”) is a medical device company dedicated to improving the quality of life of people with hearing loss. The Company’s innovative product and
Reverse stock split
In January 2023, the Company effected a reverse split of shares of the Company’s common stock on a 1-for-20 basis (the “Reverse Stock Split”). The Company’s common stock began trading on a post-split basis on January 18, 2023. The number of authorized shares of the common stock was not adjusted as a result of the Reverse Stock Split. All share and per share data in these consolidated financial statements have been retrospectively adjusted to reflect the effect of the Reverse Stock Split for all periods presented. The shares of common stock retain a par value of $0.0001 per share. Accordingly, an amount equal to the par value of the decreased shares resulting from the Reverse Stock Split was reclassified from common stock to additional paid-in capital.
DOJ investigation and settlement and claims audits
On September 21, 2021, Eargo, Inc. (the “Company”)the Company was informed that it was the target of a criminal investigation by the U.S. Department of Justice (the “DOJ”) related to insurance claims for reimbursement claims the Company submitted on behalf of its customers covered by various federal employee health plans under the Federal Employee Health Benefits (“FEHB”) program.program, which is administered by the Office of Personnel Management (the “OPM”). The investigation also pertained to Eargo’s role in customer reimbursement claim submissions to federal employee health plans (collectively, the “DOJ investigation”). Total payments the Company received from the government in relation to claims submitted under the FEHB program, as subject to the DOJ investigation, net of any product returns and associated refunds, were approximately $44.0 million. Additionally, the Company’s third-party payor with whom the Company historically had the largest volume, which is one of the carriers contracted with the OPM under the FEHB program (“largest third-party payorpayor”), conducted an audit of insurance claims for reimbursement claims (“claims”) submitted by the Company (the “Primary Audit”), which included a review of medical records. The Company was informed by the third-party payor conducting the Primary Audit that the DOJ was the principal contact related to the subject matter of the Primary Audit. On January 4, 2022, the DOJ confirmed to the Company that the investigation had been referred to the Civil Division of the DOJ and the U.S. Attorney’s Office for the Northern District of Texas and the criminal investigation was no longer active.
On April 29, 2022, the Company entered into a civil settlement agreement with the U.S. government that resolved the DOJ investigation related to the Company’s role in customer reimbursement claim submissions to various federal employee health plans under the FEHB program. The settlement agreement provided for the Company’s payment of approximately
From the time the Company learned of the DOJ investigation and until December 8, 2021, the Company continued to process orders for customers with potential insurance benefits (including FEHB program members) but suspended all claims submission activities and has offered affected customers (i.e.iswas denied or ultimately not submitted by the Company to their insurance plan for payment (the “extended right of return”).
The Company determined that customer transactions using insurance benefits as a method of direct payment occurring subsequent to learningbetween September 21, 2021 (when the Company learned of the DOJ investigation on September 21,investigation) and December 8, 2021 (when the Company temporarily stopped accepting insurance benefits as a method of direct payment) did not meet the criteria for
The Company estimatespreviously estimated that a majority of customers with unsubmitted claims as of December 31, 2021 willwould choose to return the hearing aid system if their insurance provider deniesdenied their claim or the claim iswas ultimately not submitted by the Company for payment, resulting in an increase in expected product returns from suchsales transactions that occurred prior to September 21, 2021. As a result,2021 and recorded during the Company recorded $13.3 million of estimated sales returns as a reduction in revenue in the third quarter of 2021 related to shipments to customers with potential insurance benefits. Of the $13.8 million sales returns reserve recorded as ofyear ended December 31, 2021, $11.4 million relates to unsubmitted claims that are included in accounts receivable, net.2021. Returns associated with unsubmitted claims will reduce the sales returns reserve, with a corresponding reduction in the related accounts receivable at the time the product is returned.
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Further, the Company also estimatesestimated that, in addition to the customers who choosechose to return their hearing aid systems, a significant number of customers whose claims arewere denied by insurance providerspayors or not submitted by the Company for payment maywould not pay for or return the hearing aid system. The $9.6 millionsystem, resulting in bad debt expense that was recorded during the year ended December 31, 2021 is primarily based on this estimate. Of2021.
In September 2022, the $9.6Company made the determination not to seek payment for approximately $16.1 million recorded to bad debt expense duringfrom customers with unsubmitted and unpaid claims which was accounted for as a pricing concession (the “Pricing Concession”). During the year ended December 31, 2021, $5.82022, the Company recorded a $16.1 million relatesreduction to submitted claims that have been denied or have not been paidits insurance-related accounts receivable balance along with related reduction to net revenue of $11.6 million and was written off duringan allowance for credit losses balance of $4.5 million for such unsubmitted and unpaid claims. Further, the Company simultaneously recorded a decrease in its insurance-related sales return reserve of $11.3 million along with a corresponding increase of $11.3 million to net revenue for the year ended December 31, 2021.
Liquidity and going concern
The accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America applicable to a going concern, which contemplates the realization of assets and the satisfaction of liabilities during the normal course of business. The Company has incurred losses and negative cash flows from operations since its inception and management expects to incur additional substantial losses in the foreseeable future. As of December 31, 2021,2022, the Company had cash and cash equivalents of
In June 2022, the Company entered into a note purchase agreement (“Note Purchase Agreement”) with an affiliate of Patient Square Capital (the “PSC Stockholder”) and Drivetrain Agency Services, LLC, as administrative agent and collateral agent. Pursuant to the Note Purchase Agreement, the Company agreed to issue and sell up to $125.0 million in senior secured convertible notes (the “Notes”) of the Company, convertible into shares of common stock (the “Note Transaction”), of which the Company issued $100.0 million in June 2022 and $5.5 million in November 2022. In November 2022, the Company completed a rights offering for up to 18,750,000 newly issued shares of common stock (“Rights Offering”), as required under the terms of the Note Transaction documents and raised $27.6 million in net proceeds from existing investors. Subsequent to the Rights Offering, the outstanding Notes converted into 15,821,299 shares of the Company’s common stock (the “Conversion Shares”). The Note Transaction and Rights Offering are discussed further in Note 8.
Since the announcement of the DOJ investigation, there has been and may continue to be a significant reduction in shipments, revenue and gross margin, which has and could continue to negatively impact the Company’s liquidity and working capital, including impacting its ability to access additional capital. It is difficult to assess or predict at this time the extent to which the Company is able to validate and establish additional processes to support the submission of claims for reimbursement to health plans, including those under the FEHB program, and the future impacts of the implementation of an over-the-counter (“OTC”) hearing aid regulatory framework (which may lead insurance providers to take actions limiting the Company’s ability to access insurance coverage).
The Company believes that without anyan alternative future financing, its current resources are insufficient to satisfy its obligations as they become due within one year after the date that thethese consolidated financial statements are issued. The negative cash flows and current lack of financial resources of the Company raise substantial doubt as to the Company’s ability to continue as a going concern.
These consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might result from the outcome of the uncertainty.
Note 2. Summary of significant accounting policies
Basis of presentation and principles of consolidation
The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The consolidated financial statements include the accounts of Eargo, Inc. and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated.
Use of estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates, assumptions, and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Significant estimates and assumptions made in the accompanying consolidated financial statements include, but are not limited to, the sales returns reserve, the present value of lease liabilities, the fair value of equity securities, the fair value of financial instruments, the allowance for credit losses, the net realizable value of inventory, the fair value of assets acquired in a business combination, the useful lives of long-lived assets, accrued product warranty reserve, legal and other contingencies, certain other accruals and recoverability of the Company’s net deferred tax assets and the related valuation allowance. Management periodically evaluates its estimates, which are
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based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from those estimates.
Cash and cash equivalents
Cash and cash equivalents consist ofinclude amounts deposited in financial institutions regulated by the Federal Deposit Insurance Corporation (the “FDIC”) as well as short-term, highly liquid investments with original maturities of three months or less from the purchase date. Cashdate; cash equivalents consist primarily of amounts invested in money market accounts.
The FDIC insures cash deposits of up to $250,000. The Company regularly maintains cash balances in deposit accounts in excess of the FDIC insured limits. Additionally, the Company’s cash equivalents are held in accordance with cash sweep arrangements with financial institutions, which amounts are invested in money market accounts that are neither included on the balance sheets of such financial institutions nor insured by the FDIC. According to such cash sweep arrangements, the Company believes it should be recognized by the FDIC as the owner of assets in the event of financial institution’s failure, such as the March 10, 2023 closure of Silicon Valley Bank.
Concentration of credit risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist of demand deposit accounts, money market accounts and accounts receivable, including credit card receivables. The Company maintains its cash and cash equivalents, which may, at times, exceed federally insured limits, with financial institutions of high credit standing. As ofThrough December 31, 2021,2022, the Company has not experienced any losses on its deposit accounts and money market accounts. As of December 31, 2021,2022, the Company does not believe there is a significant financial risk from nonperformance by the issuers of the Company’s deposit accounts and money market accounts.
Approximately 93% and 74%93% of the Company’s gross accounts receivable as of December 31, 2021 and 2020, respectively, were for customers with insurance benefits, substantially all of whom were covered under the
Fair value measurement
Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability, or an exit price, in the principal or most advantageous market for that asset or liability in an orderly transaction between market participants on the measurement date.
The Company measures fair value based on a three-level hierarchy of inputs, of which the first two are considered observable and the last unobservable. Unobservable inputs reflect the Company’s own assumptions about current market conditions. The Company maximizes the use of observable inputs, where available, and minimizes the use of unobservable inputs when measuring fair value. The three-level hierarchy of inputs is as follows:
Level
Level
Level
To the extent that the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by the Company in determining fair value is greatest for instruments categorized in Level 3. A financial instrument’s level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement.
The carrying amounts reflected in the consolidated balance sheets for cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their fair values due to their short-term nature. The fair value of the Company’s outstanding term loan is estimated using the net present value of the payments, discounted at an interest rate that is consistent with a market interest rate, which is a Level 2 input. The fair value of the outstanding term loan approximates the carrying amount as the term loan bears a floating rate that approximates the market interest rate. Refer to Note 3 for discussion of certain other financial instruments.
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Convertible notes - fair value option
The Company has elected the fair value option to account for the Notes that were issued in June 2022 and remeasured the underlying liability through the Notes conversion in November 2022, as further disclosed in Notes 3 and 8. At issuance, the Company recorded the Notes at fair value with changes in fair value recorded as a component of other income (expense), net in the consolidated statements of operations and comprehensive loss with the exception of changes in fair value due to instrument-specific credit risk, which are recorded as a component of other comprehensive income. Interest expense related to the Notes is included in the changes in fair value. As a result of applying the fair value option, direct costs and fees related to the Notes were not deferred and, therefore, expensed as incurred as a component of general and administrative expenses.
Accounts receivable, net
Accounts receivable represents amounts due from third-party institutions for credit card and debit card transactions and trade accounts receivable. Trade accounts receivable are primarily insurance claims receivable amounts due from customers, which includes third-party payors and end-users. The Company adopted Accounting Standards Codification (“ASC”) Topic 326,Financial Instruments—Credit Losses(“ASC 326”)
Inventories
Inventories are stated at the lower of standard cost (which approximates actual cost on a
Property and equipment, net
Property and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization on property and equipment is calculated using the straight-line method over the estimated useful lives of the assets, generally three to five years.years. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or the estimated useful life of the asset. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation and amortization are removed from the consolidated balance sheets and any resulting gain or loss is reflected in operations in the period realized. Repairs and maintenance are expensed as incurred.
Capitalized software development costs
The Company capitalizes software purchased for internal use and qualified costs incurred in connection with the development of internal use software. Purchased software consists of software products and licenses, which are amortized over the lesser of their estimated useful life or the contractual term. Internally developed software costs incurred in the preliminary stages of development are expensed as incurred. Once an application has reached the development stage, internal and external direct costs of the development are capitalized until the software is substantially complete and ready for its intended use. The Company also capitalizes costs related to specific upgrades and enhancements when it is probable that the expenditure will result in additional functionality. Internal use software is amortized on a straight-line basis over its estimated useful life, generally three years.years. Post-implementation activities including training and maintenance are expensed as incurred. Capitalized costs less accumulated amortization are recorded as a component of property and equipment, net on the consolidated balance sheets.
Goodwill, finite-lived acquired intangible assets, and impairment
Goodwill represents the excess of the purchase price paid over the fair value of tangible and identifiable intangible net assets acquired in business combinations. In November of each fiscal year, or more frequently if indicators of impairment exist, management performs a review to determine if the carrying value of goodwill is impaired. Impairment testing is performed at the reporting unit level.
The
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Leases
The Company adopted ASC Topic842,Leases(“ASC 842”) on January 1, 2020. Results for reporting periods beginning on or after January 1, 2020 are presented under ASC 842. Prior period amounts have not been adjusted and continue to be reported in accordance with the Company’s historical accounting under previous lease guidance, ASC Topic 840, Leases. Under ASC 842, the Company determines if an arrangement is a lease at inception. Operating leases are included in operating lease(“ROU”) assets and the current and noncurrent portions of the operating lease liability are included as operating lease liabilities in the Company’s consolidated balance sheets.
Right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Operating lease ROUright-of-use assets and liabilities are recognized based on the present value of lease payments over the lease term at the commencement date of the lease. ROURight-of-use assets also include any initial direct costs incurred and any lease payments made at or before the lease commencement date, less any lease incentive received.
As the Company’s leases do not provide an implicit interest rate, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Operating lease expense is recognized on a straight-line basis over the lease term.
Product warranty
The Company provides a
Revenue recognition
The Company’s revenue is generated from the sale of products (hearing aid systems and related accessories) and services (extended warranties). These products and services are primarily sold directly to customers through the Eargo website and the Company’s sales representatives.
Identify the contract with a customer
Identify the performance obligations in the contract
The Company has elected to treat shipping and handling activities performed after a customer obtains control of products as a fulfillment activity.
Determine the transaction price and allocation to performance obligations
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Allocate the transaction price to the performance obligations in the contract.
Recognize revenue when or as the Company satisfies a performance obligation
Contract costs
The Company applies the practical expedient to recognize the incremental costs of obtaining a contract as expense when incurred if the amortization period would be one year or less. These incremental costs include processing fees paid to third-party financing vendors, who provide the Company’s customers with the option to finance their purchases. If a customer elects to utilize this service, the Company receives a
Cost of revenue
Cost of revenue consists of expenses relating to the cost of finished goods, freight, personnel costs, consumables, product warranty costs, transaction fees including(including processing fees paid to third-party financing vendors, transaction fees,vendors), reserves for excess and obsolete inventory, depreciation and amortization, and related overhead.
Research and development
Research and development expenses consist of personnel costs, travel expenses, tools, prototype materials and product certification and are charged to expense as incurred.
Sales and marketing
Sales and marketing expenses consist of personnel costs, travel expenses, consulting fees, public relations costs, direct marketing, advertising and promotional expenses and allocated facility overhead costs. The Company recorded advertising costs, which are expensed as incurred, of $41.9$19.3 million, $23.6$41.9 million and $18.6$23.6 million for the years ended December 31, 2022, 2021 and 2020, and 2019, respectively.
Stock-based compensation
The Company accounts for stock-based awards at fair value. The fair value of restricted stock units (“RSUs”) is equal to the closing price of the Company’s common stock on the grant date. The fair value of stock options and purchase rights under an employee stock purchase plan are estimated on the date of grant using the Black-Scholes option-pricing model. The fair value of the underlying common stock is the closing price of the
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expected dividend yield is zero as the Company has not paid nor does it anticipate paying any dividends on its common stock in the foreseeable future.
For stock-based awards that vest subject to the satisfaction of a service requirement, the fair value measurement date is the date of grant and the expense is recognized on a straight-line basis over the requisite service period. For stock-based awards with performance-based vesting conditions, the expense is recognized over the vesting period using the accelerated attribution method. The Company accounts for forfeitures as they occur.
Income taxes
The Company uses the asset and liability method to account for income taxes. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial statement carrying amounts of existing assets and liabilities and their tax bases. Deferred tax assets and liabilities are measured using enacted tax rates applied to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized. Financial statement effects of uncertain tax positions are recognized when it is
Segments
Operating segments are defined as components of an entity for which separate financial information is available and that is regularly reviewed by the Chief Operating Decision Maker (“CODM”) in deciding how to allocate resources to an individual segment and in assessing performance. The Company’s CODM is its Chief Executive Officer. To date, the Company has viewed its operations and manages its business as 1one operating and reportable segment, with all operations in the United States.
Employee benefit plan
The Company sponsors a qualified 401(k) defined contribution plan covering eligible employees. Participants may contribute a portion of their annual compensation limited to a maximum annual amount set by the Internal Revenue Service. There have been 0no employer contributions under this plan to date.
Net loss per share attributable to common stockholders
The Company follows the
Basic net loss per share attributable to common stockholders is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period,
Recently adopted accounting pronouncements
In December 2019, the FASBFinancial Accounting Standards Board (“FASB”) issued ASUNo.Accounting Standards Update (“ASU”) 2019-12,This new standard is effective for the Company in the fiscal year beginning January 1, 2022. An entity that elects early adoption must adopt all the amendments in the same period. The Company does not expect the adoption of this standard todid not have a material impact on itsthe Company’s consolidated financial statements.
In August 2020, the FASB issued ASUNo. 2020-06,ASCThis new standard is effective for the Company beginning January 1, 2022. The Company does not expect the adoption of this standard todid not have a material impact on itsthe Company’s consolidated financial statements.
In June 2022, the FASB issued ASU 2022-03, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions. ASU 2022-03 clarifies that contractual sales restrictions are not considered in measuring an
91
equity security at fair value and introduces new disclosure requirements for equity securities subject to contractual sale restrictions that are measured at fair value. The amendments also clarify that an entity cannot, as a separate unit of account, recognize and measure a contractual sale restriction. Early adoption is permitted for both interim and annual financial statements that have not yet been issued or made available for issuance. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
Recent accounting pronouncements not yet adopted
The Company does not believe that any recently issued accounting pronouncements and other authoritative guidance with the effective dates in the future will have material impact to its financial position or results of operations when implemented.
Note 3. Fair value measurements
There were 0no financial assets and liabilities outstanding that were remeasured at fair value on a recurring basis as of December 31, 2021 or December 31, 2020.
The following table provides a summary of the changechanges in the estimated fair value of the Company’s convertible preferred stock warrant liability:
Amount | ||||
(in thousands) | ||||
Balance — December 31, | $ | — | ||
Fair value of convertible | 105,475 | |||
Change in fair value of | 45,503 | |||
Conversion of | ( | ) | ||
Balance — December 31, | $ | — | ||
2020 | ||||
(in thousands) | ||||
Note 4. Balance sheet components
Inventories
Inventories consist primarily of raw materials related to component parts and finished goods. The following is a summary of the Company’s inventories by category:
|
| December 31, |
| |||||
|
| 2022 |
|
| 2021 |
| ||
|
| (in thousands) |
| |||||
Raw materials |
| $ | 410 |
|
| $ | 1,905 |
|
Finished goods |
|
| 4,626 |
|
|
| 3,807 |
|
Total inventories |
| $ | 5,036 |
|
| $ | 5,712 |
|
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December 31, | ||||||||
2021 | 2020 | |||||||
(in thousands) | ||||||||
Raw materials | $ | 1,905 | $ | 853 | ||||
Finished goods | 3,807 | 1,886 | ||||||
Total inventories | $ | 5,712 | $ | 2,739 | ||||
Prepaid expenses and other current assets
Prepaid expenses and other current assets consist of the following:
|
| December 31, |
| |||||
|
| 2022 |
|
| 2021 |
| ||
|
| (in thousands) |
| |||||
Advances to suppliers |
| $ | 2,000 |
|
| $ | 95 |
|
Marketing costs |
|
| 1,709 |
|
|
| 1,948 |
|
Payroll advances |
|
| 1,686 |
|
|
| 3,889 |
|
Software subscriptions |
|
| 1,553 |
|
|
| 1,468 |
|
Product launch fee |
|
| 252 |
|
|
| — |
|
Insurance costs |
|
| 78 |
|
|
| 2,945 |
|
Other |
|
| 568 |
|
|
| 528 |
|
Total prepaid expenses and other current assets |
| $ | 7,846 |
|
| $ | 10,873 |
|
December 31, | ||||||||
2021 | 2020 | |||||||
(in thousands) | ||||||||
Advanced payroll deposits | $ | 3,889 | $ | 0 | ||||
Prepaid insurance fees | 2,945 | 1,931 | ||||||
Prepaid marketing costs | 1,948 | 245 | ||||||
Prepaid software subscription | 1,468 | 995 | ||||||
Other | 623 | 569 | ||||||
Total prepaid expenses and other current assets | $ | 10,873 | $ | 3,740 | ||||
Property and equipment, net
Property and equipment, net, consists of the following:
| December 31, |
| |||||
| 2022 |
|
| 2021 |
| ||
| (in thousands) |
| |||||
Capitalized software | $ | 11,579 |
|
| $ | 11,569 |
|
Tools and lab equipment |
| 5,087 |
|
|
| 4,712 |
|
Furniture and fixtures |
| 2,440 |
|
|
| 906 |
|
Leasehold improvements |
| 993 |
|
|
| 861 |
|
Computer and equipment |
| 482 |
|
|
| 401 |
|
|
| 20,581 |
|
|
| 18,449 |
|
Less accumulated depreciation and amortization |
| (13,140 | ) |
|
| (8,898 | ) |
Total property and equipment, net | $ | 7,441 |
|
| $ | 9,551 |
|
December 31, | ||||||||
2021 | 2020 | |||||||
(in thousands) | ||||||||
Capitalized software | $ | 11,569 | $ | 6,744 | ||||
Tools and lab equipment | 4,712 | 4,426 | ||||||
Furniture and fixtures | 906 | 906 | ||||||
Leasehold improvements | 861 | 757 | ||||||
Computer and equipment | 401 | 288 | ||||||
18,449 | 13,121 | |||||||
Less accumulated depreciation and amortization | (8,898 | ) | (5,087 | ) | ||||
Total property and equipment, net | $ | 9,551 | $ | 8,034 | ||||
Depreciation and amortization expense for the years ended December 31, 2022, 2021 and 2020 and 2019 amounted to $4.2is $4.8 million, $2.5$4.2 million and $1.5$2.5 million, respectively, which includes amortization of capitalized software costs of $2.1$3.5 million, $0.8$2.1 million and $0.3$0.8 million, respectively.
Accrued expenses
Accrued expenses consist of the following:
|
| December 31, |
| |||||
|
| 2022 |
|
| 2021 |
| ||
|
| (in thousands) |
| |||||
Accrued compensation |
| $ | 8,070 |
|
| $ | 4,845 |
|
Accrued warranty reserve |
|
| 3,765 |
|
|
| 4,014 |
|
Refunds due to customers |
|
| 580 |
|
|
| 376 |
|
Other accrued expenses |
|
| 300 |
|
|
| — |
|
Total accrued expenses |
| $ | 12,715 |
|
| $ | 9,235 |
|
December 31, | ||||||||
2021 | 2020 | |||||||
(in thousands) | ||||||||
Accrued compensation | $ | 4,845 | $ | 5,861 | ||||
Accrued warranty reserve | 4,014 | 2,390 | ||||||
Refunds due to customers | 376 | 581 | ||||||
Accrued vendor costs | 0 | 751 | ||||||
Total accrued expenses | $ | 9,235 | $ | 9,583 | ||||
Sales returns reserve
The sales returns reserve consists of the following activity:
|
| Year ended December 31, |
| |||||||||
|
| 2022 |
|
| 2021 |
|
| 2020 |
| |||
|
| (in thousands) |
| |||||||||
Sales returns reserve, beginning balance |
| $ | 13,827 |
|
| $ | 4,326 |
|
| $ | 3,759 |
|
Reduction of revenue |
|
| 18,240 |
|
|
| 37,674 |
|
|
| 22,676 |
|
Decrease related to Pricing Concession |
|
| (11,263 | ) |
|
| — |
|
|
| — |
|
Utilization of sales returns reserve |
|
| (16,862 | ) |
|
| (28,173 | ) |
|
| (22,109 | ) |
Sales returns reserve, ending balance |
| $ | 3,942 |
|
| $ | 13,827 |
|
| $ | 4,326 |
|
Year ended December 31, | ||||||||||||
2021 | 2020 | 2019 | ||||||||||
(in thousands) | ||||||||||||
Sales returns reserve, beginning balance | $ | 4,326 | $ | 3,759 | $ | 2,713 | ||||||
Reduction of revenue | 37,674 | 22,676 | 17,739 | |||||||||
Utilization of sales returns reserve | (28,172 | ) | (22,109 | ) | (16,693 | ) | ||||||
Sales returns reserve, ending balance | $ | 13,828 | $ | 4,326 | $ | 3,759 | ||||||
During the year ended December 31, 2021 includes $13.3 million recorded during2022, as part of the third quarter of 2021 primarily based on the Company’s estimate that a majority of customers with unsubmitted claims will choose to return the hearing aid system if their insurance provider denies their claim or the claim is ultimately not submitted byPricing Concession, the Company for payment.
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Allowance for credit losses
The allowance for credit losses consists of the following activity:
|
| Year ended December 31, |
| |||||||||
|
| 2022 |
|
| 2021 |
|
| 2020 |
| |||
|
| (in thousands) |
| |||||||||
Allowance for credit losses, beginning balance |
| $ | 4,838 |
|
| $ | 1,868 |
|
| $ | 225 |
|
Charged to expense |
|
| 713 |
|
|
| 9,615 |
|
|
| 2,352 |
|
Accounts written off, net of recoveries |
|
| (5,393 | ) |
|
| (6,645 | ) |
|
| (709 | ) |
Allowance for credit losses, ending balance |
| $ | 158 |
|
| $ | 4,838 |
|
| $ | 1,868 |
|
Year ended December 31, | ||||||||||||
2021 | 2020 | 2019 | ||||||||||
(in thousands) | ||||||||||||
Allowance for credit losses, beginning balance | $ | 1,868 | $ | 225 | $ | 0 | ||||||
Charged to expense | 9,615 | 2,352 | 225 | |||||||||
Accounts written off, net of recoveries | (6,645 | ) | (709 | ) | 0 | |||||||
Allowance for credit losses, ending balance | $ | 4,838 | $ | 1,868 | $ | 225 | ||||||
Accrued warranty reserve
The accrued warranty reserve consists of the following activity:
|
| Year ended December 31, |
| |||||||||
|
| 2022 |
|
| 2021 |
|
| 2020 |
| |||
|
| (in thousands) |
| |||||||||
Accrued warranty reserve, beginning balance |
| $ | 4,014 |
|
| $ | 2,390 |
|
| $ | 450 |
|
Charged to cost of revenue |
|
| 2,607 |
|
|
| 3,229 |
|
|
| 3,178 |
|
Utilization of accrued warranty reserve |
|
| (2,856 | ) |
|
| (1,605 | ) |
|
| (1,238 | ) |
Accrued warranty reserve, ending balance |
| $ | 3,765 |
|
| $ | 4,014 |
|
| $ | 2,390 |
|
Year ended December 31, | ||||||||||||
2021 | 2020 | 2019 | ||||||||||
(in thousands) | ||||||||||||
Accrued warranty reserve, beginning balance | $ | 2,390 | $ | 450 | $ | 53 | ||||||
Charged to cost of revenue | 3,229 | 3,178 | 1,589 | |||||||||
Utilization of accrued warranty reserve | (1,605 | ) | (1,238 | ) | (1,192 | ) | ||||||
Accrued warranty reserve, ending balance | $ | 4,014 | $ | 2,390 | $ | 450 | ||||||
Note 5. Acquisitions
In June 2021, the Company completed the purchase of certain$2.9$2.9 million in cash, all of which has been paid as of December 31, 2021. This purchase was accounted for as a business combination. Clementine offers remote audiology solutions and self-administered hearing screen technology to consumers across digital and
The table below presents the purchase price allocation:
|
| Amount |
| |
|
| (in thousands) |
| |
Goodwill |
| $ | 873 |
|
Intangible assets |
|
| 1,990 |
|
Total fair value of consideration |
| $ | 2,863 |
|
(in thousands) | ||||
Goodwill | $ | 873 | ||
Intangible assets | 1,990 | |||
Total fair value of consideration | $ | 2,863 | ||
The intangible assets acquired in the Clementine acquisition are comprised primarily of developed technologies and have a weighted-average amortization period of 3.6 years as of the date of the acquisition.
Note 6. Commitments and contingencies
Operating leases
The Company has entered into
San Jose lease
In September 2021, the Company entered into a lease agreement, as amended, for approximately 30,000 square feet of office and laboratory space located in San Jose, California, which the Company plans to usehas used as its headquarters starting insince early 2022. The lease commenced in September 2021 and has a2options.ROUright-of-use asset of $6.8$6.8 million as of commencement of the lease.
Nashville lease
94
In February 2021, the Company amended the operating lease for its Nashville, Tennessee office to extend the term of the initial lease through March 2023 and reduce the size of office space leased. This extension was accounted for as a lease modification and the Company recorded an increase to the ROUright-of-use asset and lease liability of $0.4$0.4 million at the time of the amendment.
Operating lease summary
As of December 31, 2021,2022, the Company recorded an aggregate ROUright-of-use asset of $7.2$5.8 million and an aggregate lease liability of $7.4$6.6 million in the accompanying consolidated balance sheet. The ROU asset and corresponding lease liabilityThese balances were initially estimated using a weighted-average incremental borrowing rate of 7.7%7.7%. The weighted-average remaining lease term is 7.1 years.
During the years ended December 31, 2022, 2021 and 2020, the Company incurred $1.5$1.6 million, $1.5 million and $1.3$1.3 million, ofrespectively, in operating lease costs. Variable lease payments for operating expenses and costs related to short-term leases were immaterial for the years ended December 31, 2021 and 2020. For the years ended December 31, 2022, 2021 and 2020, net cash paid for amounts included in the measurement of operating lease liabilities was $1.4$1.1 million, $1.4 million and $1.2$1.2 million, respectively.
As of December 31, 2021,2022, undiscounted future minimum lease payments due under the
|
| Amount |
| |
|
| (in thousands) |
| |
2023 |
| $ | 1,114 |
|
2024 |
|
| 1,081 |
|
2025 |
|
| 1,331 |
|
2026 |
|
| 1,372 |
|
2027 |
|
| 1,413 |
|
Thereafter |
|
| 2,193 |
|
Total minimum future lease payments |
|
| 8,504 |
|
Present value adjustment for minimum lease commitments |
|
| (1,903 | ) |
Total lease liability |
| $ | 6,601 |
|
Operating leases | ||||
(in thousands) | ||||
2022 | $ | 1,327 | ||
2023 | 1,114 | |||
2024 | 1,081 | |||
2025 | 1,331 | |||
2026 | 1,372 | |||
Thereafter | 3,607 | |||
Total minimum future lease payments | 9,832 | |||
Present value adjustment for minimum lease commitments | (2,442 | ) | ||
Total lease liability | $ | 7,390 | ||
Legal and other contingencies
The Company is involved in legal proceedings in the ordinary course of its business and may become involved in additional legal proceedings. Other than those listed below, the Company does not believe that any lawsuits or claims currently pending against it, individually or in the aggregate, are material or will have a material adverse effect on its financial condition, results of operations or cash flows. The Company may enter into settlement discussions, and may enter into settlement agreements, if it believes settlement is in the best interest of the Company and its shareholders. Unless stated otherwise, the matters discussed below, if decided adversely or settled by the Company, individually or in the aggregate, may result in a liability material to the Company’s financial condition, results of operations or cash flows.
The Company is also subject to review from federal and state taxing authorities in order to validate the amounts of income, sales and/or use taxes which have been claimed and remitted. The Company has estimated exposure and established reserves for its estimated sales tax audit liability.
In the normal course of business, the Company may agree to indemnify third parties with whom it enters into contractual relationships, including customers, lessors, and parties to other transactions with the Company, with respect to certain matters. The Company has agreed, under certain conditions, to hold these third parties harmless against specified losses, such as those arising from a breach of representations or covenants, other third-party claims that the Company’s products, when used for their intended purposes, infringe the intellectual property rights of such other third parties, or other claims made against certain parties. It is not possible to determine the maximum potential amount of liability under these indemnification obligations due to the Company’s limited history of prior indemnification claims and the unique facts and circumstances that are likely to be involved in any particular claim.
DOJ Investigation and Settlement.
On September 21, 2021, the Company was informed that it was the target of a criminal investigation by the DOJ related to insurance claims for reimbursement claims the Company submitted on behalf of its customers covered by various federal employee health plans under the FEHB program. The investigation also pertained to the Company’s role in customer reimbursement claim submissions to federal employee health plans. Additionally, the Company was the subject of an ongoing claims audit by an insurance company that iswas historically the Company’s largest third-party payor and was informed by such insurance company that the DOJ was the
95
On April 29, 2022, the Company entered into a civil settlement agreement with the U.S. government that resolved the DOJ investigation, including allegations that the Company violated the False Claims Act by knowingly submitting or causing the submission of false claims for payment under the FEHB
The settlement of the investigation may not resolve all of the claims audits of insurance reimbursement claimsinitiated by additionalvarious third-party payors, and additionally the Company remains subject to a prepayment review of claims by the payor who conducted the Primary Audit. The Company will needintends to continue to work with the government (including the OPM) andapplicable third-party payors to potentially validate and establish processes to support any future claims that it may submit for reimbursement, and there are no guarantees that the Company will be able to arrive at any such acceptable processes or submit any future claims. The Company does not intendclaims in sufficient volume to submit any claims through the FEHB program until it is able to align with the OPM on and establish processes for supporting the submission of these claims.
Securities Class
On October 6, 2021, putative shareholder Joseph Fazio filed a purported securities class action against the Company and certain of its officers, captioned Fazio v. Eargo, Inc., et al., No. 21-cv-07848 (N.D. Cal. Oct. 6, 2021) (the “Fazio action”Action”). Plaintiff Fazio alleges that certain of the Company’s disclosures about its business, operations, and prospects, including reimbursementsreimbursement from third-party payors, violated federal securities laws. Fazio voluntarily dismissed his complaint on December 6, 2021. On November 4, 2021, putative shareholder Alden Chung filed a substantially similar purported class action lawsuit substantially similar to the Fazio Action, captioned Chung v. Eargo, Inc., et al., No. 21-cv-08597 (N.D. Cal. Nov. 4, 2021) (the “Chung action”Action”). On November 10, 2021, putative shareholder IBEW Local 353 Pension Plan filed a similar purported class action substantially similar to the Fazio and Chung Actions and also assertedasserting claims under the federal securities laws against current and former members of the Company’s Board of Directors (the “Board of Directors”) and the underwriters of the Company’s October 15, 2020 initial public offering of common stock, captioned IBEW Local 353 Pension Plan v. Eargo, Inc., et al., No. 21-cv-08747 (N.D. Cal. Nov. 10, 2021) (the “IBEW action”Action”). These class actions, which seek damages and other relief, were filed in the U.S.United States District Court for the Northern District of California. The Fazio and Chung actionsActions were brought purportedly on behalf of a class of investors who purchased or otherwise acquired Eargo securities between February 25, 2021 and September 22, 2021. The IBEW Local 353 actionAction was brought purportedly on behalf of a class of investors who purchased or otherwise acquired: (i) Eargo shares in or traceable to the Company’s October 15, 2020 initial public offering of common stock; and/or (ii) shares of Eargo common stock between October 15, 2020 and September 22, 2021. On January 5, 2022, the court consolidated the foregoing class actions (as consolidated, the “Securities Class Action”) under the caption have not yet filed a consolidated amended complaint.
The Company intends to vigorously defend the Securities Class Action and cannot reasonably estimate any loss or range of loss that may arise from the litigation. Accordingly, the Company can provide no assurance as to the scope and outcome of this matter and no assurance as to whether its business, financial position, results of operations, or cash flows will not be materially adversely affected.
Derivative Action.
On December 3, 2021, putative shareholder Barbara Wolfson filed a derivative complaint purportedly on Eargo’sthe Company’s behalf against members of the Board of Directors and the Company as nominal defendant, captioned Wolfson v. Gormsen, et. al., No. 21-cv-09342 (N.D. Cal. Dec. 3, 2021) (the “Derivative“Wolfson Action”). Plaintiff asserts, among other things, that the defendants breached their fiduciary duties by allegedly failing to implement and maintain an effective system of internal controls related to the Company’s financial reporting, public disclosures and compliance with laws, rules and regulations governing the business. Plaintiff purports to assert derivative claims on the Company’s behalf for alleged violations of Section 14(a) of the Securities Exchange Act of 1934, as amended, breach of fiduciary duty, waste of corporate assets, and aiding and abetting. On March 1, 2022, the court entered the parties’ stipulation staying the DerivativeWolfson Actionanticipatedresolution of the motion to dismiss in the Securities Class Action. On June 9, 2022, putative shareholder Brodie Woodward filed a derivative complaint purportedly on Eargo’s behalf against the same defendants as in the Wolfson Action, is decided.
96
The defendants intend to vigorously defend the Derivative Action and cannot reasonably estimate any loss or range of loss that may arise from the litigation.litigations. Accordingly, the Company can provide no assurance as to the scope and outcome of this matterthese matters and no assurance as to whether its business, financial position, results of operations, or cash flows will not be materially adversely affected.
Proxy Statement Class Action
On September 14, 2022, putative shareholder Adam C. Wolfe filed a purposed securities class action against members of the Board of Directors and the Company as nominal defendant, captioned Wolfe v. Gormsen, et al., No. 2022-0812-MTZ (Del. Ch. Sept. 14, 2022) (the “Wolfe Action”). Plaintiff Wolfe asserted, among other things, breaches of fiduciary duty by the Board of Directors in connection with the Note issuance, as well as that the Company’s proxy statement omitted material information concerning the Note issuance. Plaintiff Wolfe sought injunctive relief and attorneys’ fees and costs, among other remedies. Although the Company believes no supplemental disclosures were required under applicable law, to alleviate the costs, risks and uncertainties inherent in litigation, avoid any potential delay in the Company’s annual meeting of stockholders or the Rights Offering and provide additional information to its stockholders, on October 3, 2022, the Company filed a Current Report on Form 8-K to voluntarily supplement its proxy statement disclosures. On October 17, 2022, Plaintiff Wolfe filed a notice of dismissal with the court, which the court granted on October 24, 2022. On March 15, 2023, the parties agreed that the Company would pay $249,500 to Plaintiff Wolfe’s counsel in full satisfaction of Plaintiff Wolfe’s claim for attorneys’ fees and expenses in the Wolfe Action. The court was not asked to review, and did not pass judgment on, the payment of the attorneys’ fees and expenses or their reasonableness. As of December 31, 2022, the Company recorded a settlement liability in such amount in the consolidated balance sheets.
Note 7. Goodwill and intangible assets
Goodwill
The changes in the carrying amountCompany recorded goodwill of goodwill are as follows:
Total | ||||
(in thousands) | ||||
Balance December 31, 2020 | $ | 0 | ||
Addition due to business acquisition | 873 | |||
Balance December 31, 2021 | $ | 873 | ||
Intangible assets, net
Intangible assets, net consist of the following as of December 31, 2021:following:
|
| December 31, 2022 |
| |||||||||
|
| Gross carrying value |
|
| Accumulated amortization |
|
| Net carrying value |
| |||
|
| (in thousands) |
| |||||||||
Developed technologies |
| $ | 1,700 |
|
| $ | 637 |
|
| $ | 1,063 |
|
Other |
|
| 290 |
|
|
| 290 |
|
|
| — |
|
Total intangible assets, net |
| $ | 1,990 |
|
| $ | 927 |
|
| $ | 1,063 |
|
Gross carrying value | Accumulated amortization | Net carrying value | ||||||||||
(in thousands) | ||||||||||||
Developed technologies | $ | 1,700 | $ | 212 | $ | 1,488 | ||||||
Other | 290 | 97 | 193 | |||||||||
Total intangible assets, net | $ | 1,990 | $ | 309 | $ | 1,681 | ||||||
Amortization expense was $0.3$0.6 million and $0.3 million for the yearyears ended December 31, 2022 and 2021. The Company did 0t record any impairmentsThere was no impairment of intangible assets during the yearyears ended December 31, 2022 and 2021.
|
| Amount |
| |
|
| (in thousands) |
| |
2023 |
| $ | 425 |
|
2024 |
|
| 425 |
|
2025 |
|
| 213 |
|
Total |
| $ | 1,063 |
|
Amount | ||||
(in thousands) | ||||
2022 | $ | 618 | ||
2023 | 425 | |||
2024 | 425 | |||
2025 | 213 | |||
Total | $ | 1,681 | ||
Note 8. DebtRights Offering and debt obligations
Note Purchase Agreement and Rights Offering
First Tranche Closing
On June 24, 2022, the Company entered into the Note Purchase Agreement with the PSC Stockholder and Drivetrain Agency Services, LLC, as administrative agent and collateral agent. Pursuant to the Note Purchase Agreement, the Company agreed to issue and sell up to $125.0 million of Notes. On June 28, 2022 (the “First Tranche Closing”), the Company closed the initial issuance of $100.0 million of Notes (the “First Tranche Notes”). As a result of applying the fair value option, direct costs and fees related to the Notes of $5.7 million were expensed as incurred to general and administrative expenses. The maturity date of the Notes was expected
97
on the one-year anniversary of the First Tranche Closing, subject to earlier conversion, redemption or repurchase as provided by their terms.
Rights Offering
In October 2022, the Company’s stockholders approved the Rights Offering for an aggregate of 18,750,000 shares of common stock to the Company’s stockholders at a fixed offering price of $10.00 per share of common stock. On November 23, 2022, the Company completed the Rights Offering and existing shareholders subscribed to purchase 2,928,701 shares of the Company’s common stock resulting in net proceeds of $27.6 million to the Company.
Second Tranche Closing
Pursuant to the Note Purchase Agreement, the noteholders agreed to purchase up to an additional $25.0 million of Notes if the Company completed the Rights Offering within 150 days from the First Tranche Closing and the Company’s existing stockholders subscribed to purchase less than 3,750,000 shares. On November 23, 2022, following the completion the Rights Offering, the Company issued an additional $5.5 million of the aggregate principal amount of the Notes (the “Second Tranche Notes”).
Issuance of Conversion Shares
On November 23, 2022, the First Tranche Notes converted into 15,000,000 shares of the Company’s common stock. On November 25, 2022, the Second Tranche Notes converted into 821,299 shares of the Company’s common stock. Following the conversion, the PSC Stockholder beneficially owned the Conversion Shares representing approximately 76.3% of the Company’s common stock (“Change in Control”). The estimated fair value of the Conversion Shares of $151.0 million was based on the closing prices of the Company’s common stock on the conversion dates adjusted for the impact of certain legal restrictions on the Conversion Shares.
2018 Loan Agreement
In June 2018, the Company entered into a Loan and Security Agreement (the “2018 Loan Agreement”) with Silicon Valley Bank. Under the terms of the 2018 Loan Agreement, Silicon Valley Bank made available to the Company term loans in an aggregate principal amount of $12.5$12.5 million and the Company borrowed $7.0$7.0 million in 2018. The Company’s existing subsidiaries are,were, and any additional future domestic subsidiaries of the Company arewere required to be
In January 2019, the Company executed the First Amendment to the Loan and Security Agreement, which extended the interest-only period for all borrowings under the agreement until January 2020. No other terms were amended. In June 2019, the Company borrowed an additional $5.0$5.0 million to increase the total principal balance to $12.0$12.0 million. In connection with the June 2019 borrowing, the Company issued Silicon Valley Bank warrants to purchase 14,999 shares of Series C convertible preferred stock.
In May 2020, the Company executed the Second Amendment to its Loan and Security Agreement, which deferred the principal payments due between May 2020 and July 2020 such that the deferred amounts will be repaid in equal monthly payments that started in August 2020 through the scheduled maturity of the loan in June 2022. The amendment was accounted for as a modification.
In September 2020, the Company executed the Third Amendment to the Loan and Security Agreement (the “Third Amendment”), under which Silicon Valley Bank made available to the Company additional term loans in an aggregate principal amount of $20.0$20.0 million through December 31, 2020. The Company borrowed $15.0$15.0 million in September 2020 and used $10.2$10.2 million of the proceeds to repay the outstanding balance of $9.5$9.5 million and final payment fee of $0.7$0.7 million, or 6.0%6.0% of the original aggregate principal amount, on the existing term loan. The Company’s ability to borrow any additional principal under the Third Amendment expired unused on December 31, 2020.
Subsequent to the Third Amendment, maturesthe term loan had a maturity date in September 2024 with interest-only monthly payments until January 2022, which was extended to July 2022 upon the completion of the Company’s IPO in October
In June 2022, in connection with the Third Amendment are collateralized by substantially allNote Transaction, the assetsCompany repaid the outstanding balance of $15.0 million, as well as a prepayment fee of $0.3 million and a final payment fee of $0.9 million, and terminated the 2018 Loan Agreement. In connection with the repayment of the 2018 Loan Agreement, the Company excluding intellectual property (but including rights to payment and proceeds thereof). The Third Amendment contains customary affirmative and restrictive covenants, including with respect to the Company’s ability to enter into fundamental transactions, incur additional indebtedness, grant liens, pay any dividend or make any distributions to its holders, make investments, merge or consolidate with any other person or engage in transactions with the Company’s affiliates, but do not include any financial covenants. recognized a loss on extinguishment of $0.8 million.
The Company was in compliance with all of the covenantshad no outstanding debt as of December 31, 2021.2022. The balance of the term loans as of December 31, 2021 is as follows:
98
|
| December 31, |
| |
|
| 2021 |
| |
|
| (in thousands) |
| |
Principal value of long-term debt |
| $ | 15,000 |
|
Net of debt discount and accretion of final payment |
|
| 257 |
|
Long-term debt, current and noncurrent |
|
| 15,257 |
|
Less: Long-term debt, current portion |
|
| (3,333 | ) |
Long-term debt, noncurrent portion |
| $ | 11,924 |
|
During the years ended December 31, 2022, 2021 and 2020, and 2019,for the 2018 Loan Agreement, the Company recognized interest expense related to the term loans of $1.1$0.5 million, $1.0$1.1 million, and $0.7 million, respectively, which is inclusive of amortization of debt discount. The effective interest rate was 7.12% as of December 31, 2021.
December 31, | ||||||||
2021 | 2020 | |||||||
(in thousands) | ||||||||
Principal value of long-term debt | $ | 15,000 | $ | 15,000 | ||||
Net of debt discount and accretion of final payment | 257 | (163 | ) | |||||
Long-term debt, current and noncurrent | 15,257 | 14,837 | ||||||
Less: Long-term debt, current portion | (3,333 | ) | 0 | |||||
Long-term debt, noncurrent portion | $ | 11,924 | $ | 14,837 |
Total | ||||
(in thousands) | ||||
2022 | $ | 3,950 | ||
2023 | 7,038 | |||
2024 | 6,028 | |||
Total future payments | 17,016 | |||
Less amounts representing interest | (1,078 | ) | ||
Less final payment | (938 | ) | ||
Total principal amount of term loan payments | $ | 15,000 |
Note 10.9. Stock-based compensation
Total stock-based compensation is as follows:
|
| Year ended December 31, |
| |||||||||
|
| 2022 |
|
| 2021 |
|
| 2020 |
| |||
|
| (in thousands) |
| |||||||||
Cost of revenue |
| $ | 126 |
|
| $ | 738 |
|
| $ | 60 |
|
Research and development |
|
| 1,039 |
|
|
| 6,939 |
|
|
| 822 |
|
Sales and marketing |
|
| 2,720 |
|
|
| 11,213 |
|
|
| 1,629 |
|
General and administrative |
|
| 6,080 |
|
|
| 8,841 |
|
|
| 2,578 |
|
Total stock-based compensation |
| $ | 9,965 |
|
| $ | 27,731 |
|
| $ | 5,089 |
|
Year ended December 31, | ||||||||||||
2021 | 2020 | 2019 | ||||||||||
(in thousands) | ||||||||||||
Cost of revenue | $ | 738 | $ | 60 | $ | 16 | ||||||
Research and development | 6,939 | 822 | 232 | |||||||||
Sales and marketing | 11,213 | 1,629 | 188 | |||||||||
General and administrative | 8,841 | 2,578 | 903 | |||||||||
Total stock-based compensation | $ | 27,731 | $ | 5,089 | $ | 1,339 | ||||||
Stock-based compensation costs capitalized as part of capitalized software costs was $0.9$0.9 million and $0.2$0.2 million during the years ended December 31, 2021 and 2020. NaN suchNo stock-based compensation costs were capitalized during the yearsyear ended December 31, 2019.
Equity incentive plans
In November 2010, the Company adopted the 2010 Equity Incentive Plan (the “2010 Plan”) under which the Board had the authority to issue stock options to employees, directors and consultants.
As of December 31, 2021, 5,106,2232022, 231,437 shares of common stock are issuable upon the exercise of outstanding awards under the 2010 Plan. As of December 31, 2021,2022, the Company had reserved 6,991,055471,015 shares of common stock for issuance under the 2020 Plan, of which 6,244,669 are205,926 shares were available for issuance in connection with grants of future awards.
As a result of the uncertainty created by the DOJ investigation and the claims audits, on November 9, 2021, the Company suspendedtemporarily restricted its practice ofemployees from selling Company common stock, ceased granting equitystock option awards to new hires, except for newand restricted stock unit grantsunits (“RSUs”) that thesettle solely in Company has the option to settle in cash at the time of vesting,common stock, suspended its ESPP and deferredpaused the settlement of outstanding RSUs, each effective as of November 9, 2021.
The Board of Directors also determined to suspend the
99
Stock options
Stock option activity for the year ended December 31, 20212022 is set forth below:
|
| Number of |
|
| Weighted |
|
| Weighted |
|
| Aggregate |
| ||||
|
|
|
|
|
|
|
| (in years) |
|
| (in thousands) |
| ||||
Balance December 31, 2021 |
|
| 270,195 |
|
| $ | 97.36 |
|
|
| 7.88 |
|
| $ | 12,860 |
|
Grants |
|
| 64,391 |
|
|
| 26.62 |
|
|
|
|
|
|
| ||
Exercises |
|
| (3,026 | ) |
|
| 44.42 |
|
|
|
|
|
|
| ||
Cancelled or forfeited |
|
| (22,245 | ) |
|
| 112.23 |
|
|
|
|
|
|
| ||
Balance December 31, 2022 |
|
| 309,315 |
|
| $ | 82.08 |
|
|
| 5.60 |
|
| $ | — |
|
Vested and exercisable as of December 31, 2022 |
|
| 213,131 |
|
| $ | 70.51 |
|
|
| 5.33 |
|
| $ | — |
|
Number of shares | Weighted average exercise price | Weighted average remaining contractual term | Aggregate intrinsic value | |||||||||||||
(in years) | (in thousands) | |||||||||||||||
Balance December 31, 2020 | 6,468,844 | $ | 2.78 | 8.77 | $ | 271,944 | ||||||||||
Grants | 323,105 | 46.97 | ||||||||||||||
Exercises | (859,200 | ) | 2.01 | |||||||||||||
Cancelled/forfeited | (525,934 | ) | 9.68 | |||||||||||||
Balance December 31, 2021 | 5,406,815 | $ | 4.87 | 7.88 | $ | 12,860 | ||||||||||
Vested and exercisable at December 31, 2021 | 2,377,275 | $ | 3.21 | 7.18 | $ | 6,585 |
The weighted-average grant-date fair value of options granted during the years ended December 31, 2022, 2021 and 2020 were $14.65, $494.40and 2019 were $24.72, $3.22 and $2.85$64.40 per share, respectively.
The aggregate intrinsic values of options outstanding and vested and exercisable were calculated as the difference between the exercise price of the options and the fair value of the Company’s common stock. The intrinsic value of options exercised during the years ended December 31, 2022, 2021 and 2020 was $32.4$0.1 million, $32.4 million and $5.0$5.0 million, respectively, and was immaterial during the year ended December 31, 2019.
As of December 31, 2021,2022, total unrecognized stock-based compensation related to outstanding unvested stock options was $13.2$6.2 million, which the Company expects to recognize over a remaining weighted-average period of 2.41.9 years.
The estimated grant-date fair value of the Company’s stock options was calculated using the Black-Scholes option pricing model, based on the following assumptions:
|
| Year ended December 31, | ||||
Valuation assumptions: |
| 2022 |
| 2021 |
| 2020 |
Expected volatility |
| 59% - 60% |
| 53%-57% |
| 60%-71% |
Expected term |
| 5.2 - 5.8 years |
| 5.8-6.7 years |
| 5.1-7.0 years |
Risk-free interest rate |
| 3.18% - 4.01% |
| 0.62%-1.11% |
| 0.23%-1.20% |
Dividend yield |
| — |
| — |
| — |
Year ended December 31, | ||||||||||||
Valuation assumptions: | 2021 | 2020 | 2019 | |||||||||
Expected volatility | 53%-57% | 60%-71% | 58%-60% | |||||||||
Expected term | 5.8-6.7 years | 5.1-7.0 years | 5.0-10.0 years | |||||||||
Risk-free interest rate | 0.62%- 1.11% | 0.23%- 1.20% | 1.46%-2.51% | |||||||||
Dividend yield | — | — | — |
Restricted stock units
Restricted stock units (“RSUs”) granted under the 2020 Plan are share awards that generally entitle the holder to receive freely tradable shares of the Company’s common stock upon vesting. However, the Company has deferred the settlement of outstanding RSUs effective November 9, 2021. The RSUs cannot be transferred and the awards are subject to forfeiture if the holder’s service to the Company terminates prior to the release of the vesting restrictions.
RSU activity for the year ended December 31, 20212022 is set forth below:
|
| Number of |
|
| Weighted average |
| ||
|
|
|
|
|
|
| ||
Balance December 31, 2021 |
|
| 17,458 |
|
| $ | 866.76 |
|
RSUs granted |
|
| 181,995 |
|
|
| 59.59 |
|
RSUs vested |
|
| (9,992 | ) |
|
| 495.48 |
|
RSUs forfeited |
|
| (13,398 | ) |
|
| 232.09 |
|
Balance December 31, 2022 |
|
| 176,063 |
|
| $ | 101.76 |
|
Number of shares | Weighted average grant date fair value per share | |||||||
Unvested as of December 31, 2020 | 8,270 | $ | 50.70 | |||||
RSUs granted | 509,860 | 43.40 | ||||||
RSUs vested | (43,859 | ) | 52.34 | |||||
RSUs forfeited | (125,820 | ) | 41.36 | |||||
Unvested as of December 31, 2021 | 348,451 | $ | 43.19 | |||||
As of December 31, 2021, there were 17,310 RSUs outstanding that had vested but not settled, which were subsequently settled for $0.1 million in cash in March 2022. As of December 31, 2021,2022, there was $13.9$16.0 million of total unrecognized compensation cost related to the RSUs that is expected to be recognized over a weighted-average period of 3.4 years.
Performance-based restricted stock units
In June 2021, the Company granted 80,0004,000 RSUs with performance-based vesting conditions that primarily related to the achievement of certain minimum sales targetsof Eargo hearing aid systems and that mustwere required to be met byon or before December 31, 2022 for the awards to vest. The vesting conditions were deemed probable as of December 31, 2021. The grant date fair value of the awards was $3.0$3.0 million. NoneThe Company previously estimated that all vesting conditions were probable of thesebeing satisfied as of March 31, 2022. Subsequently, the performance-based vesting conditions became improbable of being satisfied, and the Company recorded a reduction in cumulative compensation cost of $1.8 million during the year ended December 31, 2022. These awards have vested orremained unvested and were forfeited as of December 31, 2021.
100
Employee stock purchase plan
As of December 31, 2021,2022, the Company reserved 1,109,23975,115 shares of common stock for issuance under the ESPP, of which 934,496 are66,378 shares were available for future issuance. The ESPP was suspended on November 9, 2021, and there were no offering periods in effect through December 31, 2022.
The ESPP provides for consecutive, overlapping15%15% of an employee’s eligible compensation.
The fair value of the ESPP shares is estimated using the Black-Scholes option pricing model, based on the following assumptions for the offering period that started in May 2021:
Year ended December 31, | ||||
Valuation assumptions: | 2021 | |||
Expected | 44%-57% | |||
Expected term | 0.5-2.0 years | |||
Risk-free interest rate | 0.04%-0.16% | |||
Dividend yield | — |
Subsequent to the suspension of the ESPP on November 9, 2021, all outstanding participant contribution amounts of $2.2 million were refunded to participants during the fourth quarter of 2021 and all future purchases under the current offering periods were cancelled. The Company has 0taccounted for the suspension of the ESPP as a cancellation of the ESPP and recognized $9.0 million of stock-based compensation in the fourth quarter of 2021 primarily as a result of the suspension. The Company recorded an aggregate of $17.4 million of stock-based compensation related to the ESPP for the year ended December 31, 2021, which includes the amounts recorded upon the suspension of the ESPP.
Note 10. Income taxes
For the year ended December 31, 2022, the Company recorded an income tax expense of $0.1 million. The Company did not record an income tax provision for the years ended December 31, 2021 2020 and 20192020 due to its history of operating losses. All loss before income taxes was generated in the United States for the years ended December 31, 2022, 2021 2020 and 2019.
Reconciliation of the statutory federal income tax to the Company’s effective tax is as follows:
|
| December 31, |
| |||||||||
|
| 2022 |
|
| 2021 |
|
| 2020 |
| |||
|
| (in thousands) |
| |||||||||
Income tax provision at statutory rate |
| $ | (33,011 | ) |
| $ | (33,128 | ) |
| $ | (8,370 | ) |
State income taxes, net of federal benefit |
|
| (3,280 | ) |
|
| (3,104 | ) |
|
| (826 | ) |
Change in valuation allowance |
|
| 22,731 |
|
|
| 37,792 |
|
|
| 8,720 |
|
Stock-based compensation |
|
| 101 |
|
|
| (716 | ) |
|
| (621 | ) |
Convertible debt |
|
| 9,556 |
|
|
| — |
|
|
| — |
|
Research and development tax credits |
|
| 2,439 |
|
|
| (1,210 | ) |
|
| (1,442 | ) |
Change in fair value of warrants |
|
| 10 |
|
|
| 21 |
|
|
| 326 |
|
Derivative liability and extinguishment of debt |
|
| — |
|
|
| — |
|
|
| 545 |
|
Return-to-provision adjustments |
|
| 318 |
|
|
| 308 |
|
|
| 1,261 |
|
Other |
|
| 1,236 |
|
|
| 37 |
|
|
| 407 |
|
Total current income tax provision |
| $ | 100 |
|
| $ | — |
|
| $ | — |
|
101
December 31, | ||||||||||||
2021 | 2020 | 2019 | ||||||||||
(in thousands) | ||||||||||||
Income tax provision at statutory rate | $ | (33,128 | ) | $ | (8,370 | ) | $ | (9,342 | ) | |||
State income taxes, net of federal benefit | (3,104 | ) | (826 | ) | (2,350 | ) | ||||||
Change in valuation allowance | 37,792 | 8,720 | 3,064 | |||||||||
Stock-based compensation | (716 | ) | (621 | ) | 190 | |||||||
Section 382 limitation on net operating loss and credit carryforwards | — | — | 9,956 | |||||||||
Research and development tax credits | (1,210 | ) | (1,442 | ) | (1,306 | ) | ||||||
Change in fair value of warrants | 21 | 326 | 79 | |||||||||
Derivative liability and extinguishment of debt | — | 545 | — | |||||||||
Return-to-provision | 308 | 1,261 | (413 | ) | ||||||||
Other | 37 | 407 | 122 | |||||||||
Total current income tax provision | $ | 0 | $ | 0 | $ | 0 | ||||||
The tax effects of temporary differences and carryforwards that give rise to significant portions of deferred tax assets are as follows:
|
| December 31, |
| |||||||||
|
| 2022 |
|
| 2021 |
|
| 2020 |
| |||
|
| (in thousands) |
| |||||||||
Deferred tax assets: |
|
|
|
|
|
|
|
|
| |||
Net operating loss carryforwards |
| $ | 91,036 |
|
| $ | 62,322 |
|
| $ | 35,943 |
|
Research and development credits |
|
| 3,077 |
|
|
| 5,120 |
|
|
| 3,910 |
|
Accruals and reserves |
|
| 3,067 |
|
|
| 13,597 |
|
|
| 2,986 |
|
Lease liability |
|
| 1,574 |
|
|
| 1,690 |
|
|
| — |
|
Stock-based compensation |
|
| 2,559 |
|
|
| 565 |
|
|
| 589 |
|
Interest expense carryforward |
|
| 60 |
|
|
| — |
|
|
| — |
|
Research and development capitalization |
|
| 3,695 |
|
|
| — |
|
|
| — |
|
Total deferred tax assets |
|
| 105,068 |
|
|
| 83,294 |
|
|
| 43,428 |
|
Valuation allowance |
|
| (102,957 | ) |
|
| (80,226 | ) |
|
| (42,435 | ) |
Deferred tax assets after valuation allowance |
|
| 2,111 |
|
|
| 3,068 |
|
|
| 993 |
|
Deferred tax liabilities: |
|
|
|
|
|
|
|
|
| |||
Depreciation and amortization |
|
| (736 | ) |
|
| (1,429 | ) |
|
| (993 | ) |
Right-of-use asset |
|
| (1,375 | ) |
|
| (1,639 | ) |
|
| — |
|
Total deferred tax liabilities |
|
| (2,111 | ) |
|
| (3,068 | ) |
|
| (993 | ) |
Net deferred tax assets |
| $ | — |
|
| $ | — |
|
| $ | — |
|
December 31, | ||||||||||||
2021 | 2020 | 2019 | ||||||||||
(in thousands) | ||||||||||||
Deferred tax assets: | ||||||||||||
Net operating loss carryforwards | $ | 62,322 | $ | 35,943 | $ | 29,684 | ||||||
Depreciation and amortization | — | — | — | |||||||||
Research and development credits | 5,120 | 3,910 | 2,468 | |||||||||
Accruals and reserves | 13,597 | 2,986 | 1,667 | |||||||||
Lease liability | 1,690 | — | — | |||||||||
Stock-based compensation | 565 | 589 | 345 | |||||||||
Total deferred tax assets | 83,294 | 43,428 | 34,164 | |||||||||
Valuation allowance | (80,226 | ) | (42,435 | ) | (33,714 | ) | ||||||
Deferred tax assets after valuation allowance | 3,068 | 993 | 450 | |||||||||
Deferred tax liabilities: | ||||||||||||
Depreciation and amortization | (1,429 | ) | (993 | ) | (450 | ) | ||||||
Right-of-use | (1,639 | ) | — | — | ||||||||
Total deferred tax liabilities | (3,068 | ) | (993 | ) | (450 | ) | ||||||
Net deferred tax assets | $ | 0 | $ | 0 | $ | 0 | ||||||
Due to the uncertainties surrounding the realization of deferred assets through future income, the Company has established a full valuation allowance against its deferred tax assets and, therefore, no benefit has been recognized for the net operating loss and other deferred tax assets. The valuation allowance increased by $37.8$22.7 million, $8.7$37.8 million, and $3.1$8.7 million during the years ending December 31, 2022, 2021, 2020 and 2019.
Under the Tax Cuts and Jobs Act of 2017, research and development costs are no longer fully deductible and are required to be capitalized and amortized for U.S. tax purposes, effective January 1, 2022. The mandatory capitalization requirement increases the Company’s deferred tax assets offset by a full valuation allowance.
As of December 31, 2021,2022, the Company had federal net operating loss carryforwards of approximately $252.6$374.7 million, of which $32.6$26.7 million begin to expire in the year 2030 and $220.0$348.0 million will carry over indefinitely. The Company also has state net operating loss carryovers of approximately $112.6$156.1 million available to reduce future taxable income, if any. The state carryforwards begin to expire beginning in the year 2030.
As of December 31, 2021,2022, the Company had research and development credits carryovers for federal income tax purposes of approximately $3.6$0.1 million which expire beginning in the year 2031.2031. The Company also has state research and development credit carryforwards of approximately $3.8$4.3 million as of December 31, 2021,2022, which do not expire.
Utilization of the net operating loss and credit carryforwards will be subject to an annual limitation due to the ownership percentage change limitations provided by the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitation may result in the expiration of the net operating loss carryforwards before utilization. In the event the Company has had a change of ownership, utilization of the carryforwards could be restricted. The Company’s net operating loss deferred tax asset was reduced from the prior year as a result of limitation on the utilization of net operating loss carryforwards subject to the Internal Revenue Code Section 382.
Uncertain tax positions
A reconciliation of the beginning and ending amounts of unrecognized tax benefits is as follows:
|
| December 31, |
| |||||||||
|
| 2022 |
|
| 2021 |
|
| 2020 |
| |||
|
| (in thousands) |
| |||||||||
Beginning balance |
| $ | 2,194 |
|
| $ | 1,676 |
|
| $ | 1,058 |
|
Increases (decreases) related to current year tax positions |
|
| (875 | ) |
|
| 518 |
|
|
| 618 |
|
Ending balance |
| $ | 1,319 |
|
| $ | 2,194 |
|
| $ | 1,676 |
|
December 31, | ||||||||||||
2021 | 2020 | 2019 | ||||||||||
(in thousands) | ||||||||||||
Beginning balance | $ | 1,676 | $ | 1,058 | $ | 576 | ||||||
Increases related to current year tax positions | 518 | 618 | 482 | |||||||||
Ending balance | $ | 2,194 | $ | 1,676 | $ | 1,058 | ||||||
If recognized, gross unrecognized tax benefits would not have an impact on the Company’s effective tax rate due to the Company’s full valuation allowance position. While it is often difficult to predict the final outcome of any particular uncertain tax position, the Company does not believe that the amount of gross unrecognized tax benefits will change significantly in the next twelve months.
The Company’s income tax returns for all tax years remain open to examination by federal and state taxing authorities due to the taxing authorities’ ability to adjust operating loss carryforwards.
102
The Company has elected to recognize interest and penalties related to uncertain tax positions as a component of the income tax provision. NaNNo such expenses were incurred in the years ended December 31, 2022, 2021 2020 and 2019.2020. The Company has 0tnot made any accruals for payment of interest related to unrecognized tax benefits.
Note 12.11. Net loss per share attributable to common stockholders
The following outstanding potentially dilutive common stock equivalents have been excluded from the computation of diluted net loss per share for the periods presented due to their anti-dilutive effect:
|
| Year ended December 31, |
| |||||||||
|
| 2022 |
|
| 2021 |
|
| 2020 |
| |||
Common stock options issued and |
|
| 309,315 |
|
|
| 270,195 |
|
|
| 323,442 |
|
Restricted stock units |
|
| 176,063 |
|
|
| 21,458 |
|
|
| 413 |
|
Shares issuable pursuant to ESPP |
|
| — |
|
|
| — |
|
|
| 893 |
|
Total |
|
| 485,378 |
|
|
| 291,653 |
|
|
| 324,748 |
|
Year ended December 31, | ||||||||||||
2021 | 2020 | 2019 | ||||||||||
Convertible preferred stock | — | — | 13,710,242 | |||||||||
Common stock options issued and outstanding | 5,406,815 | 6,468,844 | 3,474,052 | |||||||||
Restricted stock units | 428,451 | 8,270 | — | |||||||||
Shares issuable pursuant to ESPP | — | 17,865 | — | |||||||||
Convertible preferred stock warrants | — | — | 73,913 | |||||||||
Total | 5,835,266 | 6,494,979 | 17,258,207 | |||||||||
The following table sets forth the computation of basic and diluted net loss per share attributable to common stockholders:
|
| Year ended December 31, |
| |||||||||
|
| 2022 |
|
| 2021 |
|
| 2020 |
| |||
|
| (in thousands, except share and per share amounts) |
| |||||||||
Numerator: |
|
|
|
|
|
|
|
|
| |||
Net loss |
| $ | (157,487 | ) |
| $ | (157,754 | ) |
| $ | (39,855 | ) |
Gain on extinguishment of Series C and Series |
|
| — |
|
|
| — |
|
|
| 9,840 |
|
Net loss attributable to common stockholders, |
| $ | (157,487 | ) |
| $ | (157,754 | ) |
| $ | (30,015 | ) |
Denominator: |
|
|
|
|
|
|
|
|
| |||
Weighted-average shares used in computing net |
|
| 3,968,432 |
|
|
| 1,944,857 |
|
|
| 394,405 |
|
Net loss per share attributable to common |
| $ | (39.68 | ) |
| $ | (81.11 | ) |
| $ | (76.10 | ) |
Year ended December 31, | ||||||||||||
2021 | 2020 | 2019 | ||||||||||
(in thousands, except share and per share amounts) | ||||||||||||
Numerator: | ||||||||||||
Net loss | $ | (157,754 | ) | $ | (39,855 | ) | $ | (44,486 | ) | |||
Gain on extinguishment of Series C and Series C-1 convertible preferred stock | — | 9,840 | — | |||||||||
Net loss attributable to common stockholders, basic and diluted | $ | (157,754 | ) | $ | (30,015 | ) | $ | (44,486 | ) | |||
Denominator: | ||||||||||||
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted | 38,899,457 | 7,890,375 | 256,452 | |||||||||
Net loss per share attributable to common stockholders, basic and diluted | $ | (4.06 | ) | $ | (3.80 | ) | $ | (173.47 | ) | |||
Note 13.12. Subsequent events
Reverse stock split
On January 11, 2023, the Company announced that the Board had approved the Reverse Stock Split, and on January 17, 2023, the Reverse Stock Split was effected. The Company’s common stock began trading on a split-adjusted basis on January 18, 2023. The number of DOJ investigation
Nashville office space lease
In January 2023, the Company entered into a civil settlementlease agreement withfor approximately 17,572 square feet of office space located in Nashville, Tennessee. The initial term of the U.S. government that resolvedlease is 76 months commencing on the DOJ investigation relatedlater of April 1, 2023 or the date of substantial completion of certain tenant improvements. The Company will have the right to extend the Company’s role in customer reimbursement claim submissions to various federal employee health planslease term once for additional 5 years. Total noncancelable lease payments are $3.1 million under the FEHB program. Aslease. The Company has an option to apply the tenant improvement allowance of December 31, 2021,$0.9 million against the Company recorded a
103
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
Evaluation of disclosure controls and procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our periodic and current reports that we file under the Exchange Act of 1934, as amended, with the U.S. Securities and Exchange Commission (“SEC”), is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer, principal financial officer and principal accounting officer, as appropriate, to allow timely decisions regarding required disclosure.
As of December 31, 2021,2022, our management, with the participation and supervision of our principal executive officer, our principal financial officer, and our principal accounting officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules
Based on this evaluation, our principal executive officer, our principal financial officer and our principal accounting officer concluded that solely as a result of the material weaknesses in our internal control over financial reporting and entity level controls described below, our disclosure controls and procedures were not effective as of December 31, 20212022 to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer, our principal financial officer and our principal accounting officer, as appropriate, to allow timely decisions regarding required disclosure.
Remediation efforts on previously reported material weakness
In connection with the preparation of our financial statements in connection with our IPO and through the current reporting period, we identified a material weaknessweaknesses in our internal control over financial reporting. A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our financial statements will not be prevented or detected on a timely basis. The material weakness identified related to a lack of qualified supervisory accounting resources, including those necessary to account for and disclose certain complex transactions and for which we lacked the technical expertise to identify, analyze and appropriately record those transactions.
We have implemented, and are in the process of reviewing, corrective actions taken to improve our internal control over financial reporting to remediate this material weakness, including (i) the hiring of additional qualified supervisory resources and finance department employees and (ii) the engagement of additional technical accounting consulting resources.
In addition, in connection with the preparation of our financial statements for the financial reporting periods ended September 30, 2021 and December 31, 2021, we identified a material weakness related to a lack of sufficient qualified healthcare industry compliance and risk management resources, including those necessary to provide appropriate oversight, monitor compliance, and to identify and mitigate risks with respect to the financial reporting and disclosures of our operations. We have implemented and are in the process of implementing additional measures designed to improveenhance our internal control over financial reportingcompliance and risk management processes with respect to our operations in the healthcare industry to remediate this material weakness, including the hiring of additional qualified supervisory resources,personnel, and the engagement of additional technical accountingspecialized consulting resources and plans to hire additional finance department employees.
We cannot assure you that the measures we have taken to date, and are continuing to implement, will be sufficient to remediate the material weaknessweaknesses we have identified or avoid potential future material weaknesses. While we believe that our efforts have improved our internal control over financial reporting, remediation of the material weaknesses will require further validation and testing of the design and operating effectiveness of internal controls over a sustained period of financial reporting cycles, and we cannot assure you that we have identified all, or that we will not in the future have additional, material weaknesses.
104
Changes in internal control over financial reporting
Other than the changes intended to remediate the previously reported material weakness and the newly reported material weakness noted above, there were no changes in our internal control over financial reporting (as defined in
Management’s report on internal control over financial reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange Act Rules
As of December 31, 2021,2022, we assessed the effectiveness of our internal control over financial reporting based on the criteria for effective internal control over financial reporting under the 2013 “Internal Control—Integrated Framework,” issued by the Committee of Sponsoring Organizations, or COSO, of the Treadway Commission, under the supervision of, and with the participation of our management, including our Chief Executive Officer, Chief Financial Officer, and Chief Accounting Officer. We identified the following material weaknesses related to 1) a lack of qualified supervisory accounting resources, including those necessary to account for and disclose certain complex transactions and for which we lacked the technical experti seexpertise to identify, analyze and appropriately record
Item 9B. Other Information.
Eargo will host its 2023 Annual Meeting of Stockholders (the “Annual Meeting”) on June 7, 2023 at 11 A.M. Pacific Time. The Annual Meeting will be held entirely online. Information regarding how stockholders may attend, submit questions and vote online during the Annual Meeting will be set forth in the Company’s definitive proxy statement for the Annual Meeting. In order for a stockholder proposal under Rule 14a-8 or director nomination to be included in the proxy statement related to the Annual Meeting or otherwise to be properly brought before the Annual Meeting, stockholders must submit any such proposals or director nomination in writing by no later than April 3, 2023 to the Secretary of the Company at 2665 North First Street, Suite 300, San Jose, California 95134. Stockholders are advised to review our Amended and Restated Bylaws, which contain additional requirements for advance notice of stockholder proposals and director nominations.
Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections.
None.
105
PART III
Item 10. Directors, Executive Officers and Corporate Governance.
The information provided on or accessible through any website referenced in this Annual Report on Form10-Kis not a part of, and is not incorporated by any reference into, this Annual Report on Form10-K.
Item 11. Executive Compensation.
The information contained in the executive compensation tables that follow this discussion. In 2021, all of our executive officers were NEOs, as set forth below:
Name | 2021 base salary | |||
Christian Gormsen | $ | 550,000 | ||
William Brownie | 390,000 | |||
Adam Laponis | 390,000 |
Performance Metric | Weighting | Threshold (50% payout) | Target (100% payout) | Maximum (150% payout) | ||||||||||||
Net Revenue | 25 | % | $ | 85.0 | $ | 94.0 | $ | 103.5 | ||||||||
Non-GAAP Sales and Marketing Expenses(1) | 25 | % | 66 | % | 63 | % | 61 | % | ||||||||
Non-GAAP Operating Loss(2) | 25 | % | (37 | )% | (34 | )% | (31 | )% | ||||||||
Launch of Eargo 6 | 25 | % | | Initial launch by January 31, 2022 | |
Name | Number of shares underlying stock options (#) | Number of RSUs (#) | Grant date fair value | |||||||||
Christian Gormsen | 50,800 | 50,800 | $ | 4,891,697 | ||||||||
William Brownie | 16,500 | 16,500 | $ | 1,326,180 | ||||||||
Adam Laponis | 16,500 | 16,500 | $ | 1,325,469 |
Name and principal position | Year | Salary ($) (1) | Bonus ($) | Stock awards ($) (2) | Option awards ($) (2) | Non-equity incentive plan compensation ($) (3) | Total ($) | |||||||||||||||||||||
Christian Gormsen | 2021 | $ | 538,301 | $ | — | $ | 3,201,416 | $ | 1,690,280 | $ | 110,000 | $ | 5,539,997 | |||||||||||||||
President and Chief Executive Officer | 2020 | 452,279 | 61,982 | — | 3,149,564 | 147,911 | 3,811,736 | |||||||||||||||||||||
2019 | 502,170 | — | — | 1,022,911 | — | 1,525,081 | ||||||||||||||||||||||
William Brownie | 2021 | 369,950 | — | 867,570 | 458,610 | 58,500 | 1,754,630 | |||||||||||||||||||||
Chief Operating Officer | 2020 | 257,500 | 52,800 | — | 891,393 | 88,200 | 1,289,893 | |||||||||||||||||||||
2019 | 300,000 | — | — | 230,826 | — | 530,826 | ||||||||||||||||||||||
Adam Laponis | 2021 | 369,950 | — | 867,570 | 457,898 | 48,750 | 1,744,168 | |||||||||||||||||||||
Chief Financial Officer | 2020 | 257,500 | 52,800 | — | 998,198 | 88,200 | 1,396,698 | |||||||||||||||||||||
2019 | 161,539 | — | — | 490,510 | — | 652,049 |
Grant Date | Estimated Future Payouts Under Non-Equity Incentive Plan Awards (1) | All Other Stock Awards: Number of Shares of Stock or Units (#) (2) | All Other Option Awards: Number of Securities Underlying Options (#) (2) | Exercise or Base Price of Option Awards ($/Share) | Grant Date Fair Value of Stock and Option Awards ($) | |||||||||||||||||||||||||||
Name | Threshold ($) | Target ($) | Maximum ($) | |||||||||||||||||||||||||||||
Christian Gormsen | 55,000 | 440,000 | 605,000 | |||||||||||||||||||||||||||||
2/3/2021 | 50,800 | 63.02 | 1,690,280 | |||||||||||||||||||||||||||||
2/3/2021 | 50,800 | 3,201,416 | ||||||||||||||||||||||||||||||
William Brownie | 29,250 | 234,000 | 321,750 | |||||||||||||||||||||||||||||
1/29/2021 | 16,500 | 52.58 | 458,610 | |||||||||||||||||||||||||||||
1/29/2021 | 16,500 | 867,570 | ||||||||||||||||||||||||||||||
Adam Laponis | 24,375 | 195,000 | 268,125 | |||||||||||||||||||||||||||||
1/29/2021 | 16,500 | 52.58 | 457,898 | |||||||||||||||||||||||||||||
1/29/2021 | 16,500 | 867,570 |
Name and principal position | Grant date (1) | Vesting commencement date | Number of securities underlying unexercised options (#) (exercisable) | Number of securities underlying unexercised options (#) (unexercisable) | Equity incentive plan awards: number of securities underlying unexercised unearned options (#) (2) | Option exercise price ($) | Option expiration date | Number of shares or units of stock that have not vested (#) | Market value of shares or units of stock that have not vested ($) (3) | |||||||||||||||||||||||||||
Christian Gormsen | 4/22/2014 | 1,100 | — | — | $ | 1.29 | 4/22/2024 | |||||||||||||||||||||||||||||
President | 11/20/2014 | 11,000 | — | — | 1.29 | 11/20/2024 | ||||||||||||||||||||||||||||||
and Chief | 9/1/2016 | 37,148 | — | — | 1.29 | 9/1/2026 | ||||||||||||||||||||||||||||||
Executive Officer | 10/11/2016 | 37,148 | — | — | 1.29 | 10/11/2026 | ||||||||||||||||||||||||||||||
7/12/2017 | 7/12/2017 | — | — | 18,574 | 1.29 | 7/11/2027 | ||||||||||||||||||||||||||||||
11/29/2017 | 11/29/2017 | (4) | 437,907 | — | — | 1.29 | 11/28/2027 | |||||||||||||||||||||||||||||
11/3/2018 | 4/24/2019 | (5) | 43,333 | — | — | 1.41 | 11/2/2028 | |||||||||||||||||||||||||||||
4/24/2019 | 4/24/2019 | (6) | 229,737 | — | — | 2.55 | (7) | 4/23/2029 | ||||||||||||||||||||||||||||
4/24/2019 | 2/26/2020 | (8) | 59,167 | — | — | 2.55 | (7) | 4/23/2029 | ||||||||||||||||||||||||||||
8/3/2020 | 8/3/2020 | (9) | 147,548 | 295,090 | — | 2.55 | 8/2/2030 | |||||||||||||||||||||||||||||
8/20/2020 | 8/20/2020 | (9) | 168,408 | 336,816 | — | 2.55 | 8/19/2030 | |||||||||||||||||||||||||||||
2/3/2021 | 2/15/2021 | (11) | 9,525 | 41,275 | — | 63.02 | 2/2/2031 | |||||||||||||||||||||||||||||
2/3/2021 | 2/15/2021 | (12) | 41,275 | 210,503 | ||||||||||||||||||||||||||||||||
William Brownie | 9/1/2016 | 387 | — | — | 1.29 | 9/1/2026 | ||||||||||||||||||||||||||||||
Chief Operating | 2/14/2017 | 2/14/2017 | (4) | 290 | — | — | 1.29 | 2/13/2027 | ||||||||||||||||||||||||||||
Officer | 7/12/2017 | 145 | — | — | 1.29 | 7/11/2027 | ||||||||||||||||||||||||||||||
7/12/2017 | 7/12/2017 | — | — | 9,287 | 1.29 | 7/11/2027 | ||||||||||||||||||||||||||||||
11/29/2017 | 11/29/2017 | (6) | 59,522 | — | — | 1.29 | 11/28/2027 | |||||||||||||||||||||||||||||
11/3/2018 | 4/24/2019 | (5) | 7,637 | — | — | 1.41 | 11/2/2028 | |||||||||||||||||||||||||||||
4/24/2019 | 4/24/2019 | (6) | 32,166 | — | — | 2.55 | (7) | 4/23/2029 | ||||||||||||||||||||||||||||
4/24/2019 | 2/26/2020 | (8) | 10,400 | — | — | 2.55 | (7) | 4/23/2029 | ||||||||||||||||||||||||||||
8/3/2020 | 8/3/2020 | (9) | 45,454 | 90,901 | — | 2.55 | 8/2/2030 | |||||||||||||||||||||||||||||
8/20/2020 | 8/20/2020 | (9) | 52,380 | 104,765 | — | 2.55 | 8/19/2030 | |||||||||||||||||||||||||||||
1/29/2021 | 2/15/2021 | (11) | 3,093 | 13,407 | — | 52.58 | 1/28/2031 | |||||||||||||||||||||||||||||
1/29/2021 | 2/15/2021 | (12) | 13,407 | 68,376 | ||||||||||||||||||||||||||||||||
Adam Laponis | 6/19/2019 | 7/3/2019 | (10) | 67,308 | 66,384 | — | 2.55 | (7) | 6/18/2029 | |||||||||||||||||||||||||||
Chief Financial | 8/3/2020 | 8/3/2020 | (9) | 27,736 | 55,466 | — | 2.55 | 8/2/2030 | ||||||||||||||||||||||||||||
Officer | 8/20/2020 | 8/20/2020 | (9) | 43,743 | 87,480 | — | 2.55 | 8/19/2030 | ||||||||||||||||||||||||||||
1/29/2021 | 2/15/2021 | (11) | 3,093 | 13,407 | — | 52.58 | 1/28/2031 | |||||||||||||||||||||||||||||
1/29/2021 | 2/15/2021 | (12) | 13,407 | 68,376 |
Name | Option awards | Stock awards (1) | ||||||||||||||
Number of shares acquired on exercise (#) | Value realized on exercise ($) | Number of shares acquired on vesting (#) | Value realized on vesting ($) (2) | |||||||||||||
Christian Gormsen | 9,525 | 209,773 | ||||||||||||||
Adam Laponis | 10,000 | 358,800 | 3,093 | 68,119 | ||||||||||||
William Brownie | 24,196 | 434,656 | 3,093 | 68,119 |
Name | Executive Contributions in Last Fiscal Year ($) | Company Contributions in Last Fiscal Year ($) (1) | Aggregate Earnings in Last Fiscal Year ($) (2) | Aggregate Withdrawals/ Distributions in Last Fiscal Year ($) | Aggregate Balance at December 31, 2021 ($) (3) | |||||||||||||||
Christian Gormsen | — | 21,876 | (5,683 | ) | — | 16,193 | ||||||||||||||
Adam Laponis | — | 7,104 | (1,846 | ) | — | 5,258 | ||||||||||||||
William Brownie | — | 7,104 | (1,846 | ) | — | 5,258 |
Name | Cash severance | COBRA (1) | RSU acceleration (2) | Stock option acceleration (3) | Total | |||||||||||||||
Christian Gormsen | ||||||||||||||||||||
Covered Termination (Non-CIC) | 990,000 | 26,000 | — | — | 1,016,000 | |||||||||||||||
Covered Termination (CIC) | 1,980,000 | 52,000 | 226,695 | 5,382,016 | 7,640,711 | |||||||||||||||
William Brownie | ||||||||||||||||||||
Covered Termination (Non-CIC) | 468,000 | 17,000 | — | — | 485,000 | |||||||||||||||
Covered Termination (CIC) | 624,000 | 23,000 | 73,634 | 1,150,443 | 1,871,077 | |||||||||||||||
Adam Laponis | ||||||||||||||||||||
Covered Termination (Non-CIC) | 438,750 | — | — | — | 438,750 | |||||||||||||||
Covered Termination (CIC) | 585,000 | — | 73,634 | 887,698 | 1,546,332 |
Name (1) | Fees earned or paid in cash ($) (2) | Option awards ($) (3) | All other compensation ($) | Total ($) | ||||||||||||
Josh Makower, M.D. | $ | 95,000 | $ | — | $ | — | $ | 95,000 | ||||||||
Katie Bayne | 25,125 | 196,023 | — | 221,148 | ||||||||||||
Peter Tuxen Bisgaard | 55,292 | — | — | 55,292 | ||||||||||||
Doug Hughes | 50,000 | — | — | 50,000 | ||||||||||||
Geoff Pardo | 31,882 | — | — | 31,882 | ||||||||||||
Nina Richardson | 47,500 | — | — | 47,500 | ||||||||||||
A. Brooke Seawell | 60,000 | — | — | 60,000 | ||||||||||||
Juliet Tammenoms Bakker | 25,396 | — | — | 25,396 | ||||||||||||
David Wu | 44,011 | — | — | 44,011 |
subject to outstanding options | ||||
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The following table provides information on our equity compensation plans as of December 31, 2021. Information isrequired to be included for equity compensation plans approved by our stockholders.
Name | Number of securities to be issued upon exercise of outstanding options, warrants and rights | Weighted- average exercise price of outstanding options, warrants and rights | Number of securities remaining available for future issuance under equity compensation plans | |||||||||
Equity compensation plans approved by security holders (1)(2)(3) | 5,835,266 | $ | 4.87 | (4) | 7,179,165 | (5) | ||||||
Equity compensation plans not approved by security holders | ||||||||||||
Total | 5,835,266 | $ | 4.87 | 7,179,165 | ||||||||
Name of beneficial owner | Number of outstanding shares beneficially owned | Number of shares exercisable within 60 days | Number of shares beneficially owned | Percentage of beneficial ownership | ||||||||||||
5% and greater stockholders: | ||||||||||||||||
Entities affiliated with New Enterprise Associates (1) | 4,520,670 | — | 4,520,670 | 11.49 | % | |||||||||||
Cooperatieve Gilde Healthcare V U.A. (2) | 2,996,686 | — | 2,996,686 | 7.62 | % | |||||||||||
Entities affiliated with Pivotal Alpha Limited (3) | 2,886,724 | — | 2,886,724 | 7.34 | % | |||||||||||
The Charles and Helen Schwab Living Trust U/A DTD 11/22/1985 | 2,062,684 | — | 2,062,684 | 5.24 | % | |||||||||||
Named executive officers and directors: | ||||||||||||||||
Christian Gormsen (4) | 87,887 | 1,198,089 | 1,285,976 | 3.17 | % | |||||||||||
William Brownie (5) | 180,020 | 225,419 | 405,439 | 1.02 | % | |||||||||||
Adam Laponis (6) | 47,578 | 186,778 | 234,356 | * | ||||||||||||
Josh Makower, M.D. (7) | 508 | 6,666 | 7,174 | * | ||||||||||||
Katie Bayne (8) | — | 2,581 | 2,581 | * | ||||||||||||
Peter Tuxen Bisgaard (9) | 2,928,694 | 6,666 | 2,935,360 | 7.46 | % | |||||||||||
Doug Hughes (10) | 35,709 | 16,391 | 52,100 | * | ||||||||||||
Nina Richardson (11) | — | 43,723 | 43,723 | * | ||||||||||||
A. Brooke Seawell (12) | 394 | 16,391 | 16,785 | * | ||||||||||||
David Wu (13) | 1,552,369 | 6,666 | 1,559,035 | 3.96 | % | |||||||||||
All current directors and executive officers as a group (10 persons) | 4,833,158 | 1,709,370 | 6,542,528 | 16.63 | % |
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required to be included by Item 13 will be a party;
Item 14.Principal Accountant Fees and restated investors’ rights agreement with the purchasers of our convertible preferred stock, which was subsequently converted into common stock in connection with the IPO, and certain of our other stockholders, including certain of our directors and executive officers, holders of more than 5% of our capital stock and entities with which certain of our directors are affiliated. As of December 31, 2021, the holders of approximately 8.7 million shares of our common stock are entitled to rights with respect to the registration of their shares under the Securities Act.
The information required to be a participant, where the amount involved exceeds $120,000 and a related person had orincluded by Item 14 will have a direct or indirect material interest, including, without limitation, purchases of goods or services by or from the related person or entities in which the related person has a material interest, indebtedness, guarantees of indebtedness and employment by us of a related person. In reviewing and approving any such transactions, our Audit Committee considers all relevant facts and circumstances, including, but not limited to, whether the transaction is on terms comparable to those that could be obtained in an arm’s length transaction with an unrelated third party and the extent of the related person’s interestincluded in the transaction. The amendedProxy Statement for our 2023 Annual Meeting of Stockholders and restated investors’ rights agreement was entered into prior to the adoption of this policy.
2021 | 2020 | |||||||
(in thousands) | ||||||||
Audit fees (1) | $ | 1,988 | $ | 1,625 | ||||
Audit-related fees (2) | — | — | ||||||
Tax fees (3) | 57 | 37 | ||||||
All other fees (4) | — | — | ||||||
Total | $ | 2,045 | $ | 1,662 | ||||
106
PART IV
Item 15. Exhibits, Financial Statement Schedules.
We have filed the following documents as part of this Annual Report on Form 10-K:
Item 16. Form
None.
107
Exhibit Index
108
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| Incorporated by reference
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Exhibit Number
| Description
| Form
| Dated
| Number
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10.17 | S-1 | 9/25/2020 | 10.15 | |
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10.18 | 10-Q | 5/12/2021 | 10.1 | |
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10.19 | 10-Q | 5/13/2022 | 10.1 | |
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10.20 | 10-Q | 5/13/2022 | 10.2 | |
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10.21 | 8-K | 5/02/2022 | 10.1 | |
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10.22 | 8-K | 6/27/2022 | 10.1 | |
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10.23 | Form of Indemnification Agreement entered into with Investor Directors. * | 8-K | 6/27/2022 | 10.2 |
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10.24 | Board Observer Agreement, dated June 24, 2022, by and between Eargo, Inc. and PSC Echo LP.* | 8-K | 6/27/2022 | 10.3 |
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10.25 | 8-K | 6/27/2022 | 10.4 | |
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10.26 | 8-K | 6/27/2022 | 10.5 | |
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21.1 |
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23.1 | Consent of Deloitte & Touche LLP, independent registered public accounting firm.† |
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24.1 |
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31.1 |
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31.2 |
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32.1 |
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32.2 |
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101.INS | Inline XBRL Instance Document† |
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101.SCH | Inline XBRL Taxonomy Extension Schema Document† |
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101.CAL | Inline XBRL Taxonomy Extension Calculation Linkbase Document† |
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101.DEF | Inline XBRL Taxonomy Extension Definition Linkbase Document† |
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101.LAB | Inline XBRL Taxonomy Extension Label Linkbase Document† |
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101.PRE | Inline XBRL Taxonomy Extension Presentation Linkbase Document† |
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109
Incorporated by reference | ||||
Exhibit Number | Description | Form | Dated | Number |
104 | Cover Page Interactive Data File (embedded within the Inline XBRL document)† |
# Indicates management contract or compensatory plan.
+ Certain schedules and exhibits to this agreement have been omitted pursuant to Item 601(a)(5) of Contents
† Filed herewith.
‡ Furnished herewith.
110
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized
Eargo, Inc. | ||||||
Date: | By: | /s/ Christian Gormsen | ||||
Christian Gormsen | ||||||
President and Chief Executive Officer |
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Report has been signed below by the following persons on behalf of the Registrant in the capacities and on the dates indicated.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Christian Gormsen, Adam Laponis and Christy La Pierre, and each of them, as his or her true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming that all said attorneys-in-fact and agents, or any of them or their or his or her substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Name | Title | Date | ||
/s/ Christian Gormsen Christian Gormsen | President, Chief Executive Officer and Director (Principal Executive Officer) | March 23, 2023 | ||
/s/ Adam Laponis Adam Laponis | Chief Financial Officer (Principal Financial Officer) | March 23, 2023 | ||
/s/ Mark Thorpe Mark Thorpe | Chief Accounting Officer (Principal Accounting Officer) | March 23, 2023 | ||
/s/ Donald Spence | Chair of the Board of Directors | March 23, 2023 | ||
/s/ Katie J. Bayne Katie J. Bayne | Director | March 23, 2023 | ||
/s/ Trit Garg, M.D. | Director | March 23, 2023 | ||
/s/ Karr Narula | Director | March 23, 2023 | ||
/s/ Justin Sabet-Peyman | Director | March 23, 2023 | ||
/s/ David Wu David Wu | Director | March 23, 2023 |
111